On the issue of how Democrats will approach tax policy now that they control Congress, much attention has been paid to one thing — whether taxes will go up.

For now, incoming House Ways and Means Chairman Charlie Rangel, D-N.Y., says he will stay away from the question of whether to extend or make permanent an array of pro-entrepreneur tax relief measures that are set to expire in 2010. Instead, Rangel is planning to focus on Alternative Minimum Tax (AMT) relief for some taxpayers, and closing loopholes on others (mostly corporations and "the wealthy"). Another priority, closing the "tax gap," will surely get the attention of small business owners.

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Certainly, tax compliance is a critical issue. A central drawback, however, to proposals that aim to close the "gap" is that faithful compliers will be burdened with new requirements. In other words, everyone pays for the sins of the few.

"Current suggestions for closing the tax gap … are only Band-Aids on massive hemorrhaging and would only impose additional burdens on small business owners," said renowned small business tax expert Barbara Weltman.

Many of the proposals to close the tax gap will require, for example, additional reporting and filing requirements — translation: more paperwork.

Already, according to Small Business Administration (SBA) Office of Advocacy research, the cost of tax compliance for small firms is 67 percent higher than for their larger counterparts. For firms with less than twenty employees, the per-employee cost of complying with the tax code is $1,304 (note: this figure represents compliance costs only, and does not include tax payments such as payroll taxes, etc.).

"Tax Gap" Primer

In February of this year the Internal Revenue Service (IRS) updated its estimate of the tax gap. For tax year 2001 (the most recent year that was reviewed through an agency research project) it was estimated that the gross tax gap, which is "the difference between what taxpayers should have paid and what they actually paid on a timely basis," was $345 billion. After accounting for enforcement efforts, the IRS recovered about $55 billion of this amount.

Click here to see the IRS' announcement of the updated tax gap estimate.

Over the years, federal lawmakers and various administrations have implemented an array of tactics to increase compliance. Now, current budget pressures have put the issue of closing the tax gap at center stage. After all, lawmakers are on the hunt for revenues to pay for new spending programs or tax reform measures.

Indeed, it was the Republican-led Congress in the spring of this year that advanced the new 3 percent withholding mandate on government contractors at all levels. That stealth requirement was ostensibly passed as an offset to pay for various tax relief extensions soon set to expire.

The justification for the new mandate is that some government contractors are not paying their taxes. Weltman suggests that this initiative may be the prelude to withholding mandates on many small businesses in general.

Using Third Parties

Targeting third parties to help increase compliance is an attractive approach for lawmakers and administration officials alike. Businesses of all sorts would be required to provide more information about taxpayers to the IRS to help track transactions and the accuracy of information.

For example, the Bush administration is proposing that credit card companies report reimbursements made to small merchants. In October, the Senate Finance Committee released a set of discussion options developed by the congressional Joint Committee on Taxation which included possible reporting requirements for mortgage interest, proceeds of auctions sales, real estate taxes, the basis for publicly-traded securities, and for individuals with an interest in offshore bank accounts and offshore trusts.

Some have suggested that businesses or individuals should be required to withhold taxes on all independent contractors and self-employed individuals since, according to the IRS, they contribute significantly to the tax gap as a group. IRS officials have also suggested that businesses should be forced to withhold payments from taxpayers who presumably owe money to the IRS.

Such proposals, according to small business tax consultant Leonard Steinberg, may have unintended consequences for those businesses or individuals forced to withhold.

"Does the contractor then become a different class of employee and will [they] lose all the tax incentives for being ‘independent'?" Steinberg said.

One does have to wonder how mandates regarding health coverage, workplace regulations and other tax requirements are interpreted if such proposals advance. Getting entangled in tax disputes between the IRS and an independent contractor is not an appealing situation for business owners either.

Is There a Better Way?

Both Weltman and Steinberg believe that improving compliance rests on a critical initiative — simplifying the tax system.

"The issue is systemic and will take years to resolve as long as the tax code remains so complex," said Steinberg.

He favors a flat tax and points to success in former Soviet bloc nations that have established such a system. Tax collections have soared and so has economic growth. Steinberg suggests implementing a flat tax as an experiment, for 2-3 years.

"That should give the economists enough time and data to adequately analyze the effects of this type of tax," he says.

Weltman recommends easy and consistent rules, certainty with respect to tax changes and notes the importance of lowering tax rates. "It simply wouldn't pay to cheat," she said.

Steinberg strongly supports increasing IRS resources to effectively carry out their core tax collection and enforcement responsibilities. According to a recent report by the National Treasury Employees Union, the number of revenue officers and revenue agents decreased by 40 and 30 percent respectively from 1995 to 2003, while tax returns grew from 114.6 million to 130.3 million.

Steinberg and Weltman are in agreement that "tax gap" proposals will not pay off. Yet, unfortunately, small business owners play a big role in Washington's plans in trying to close the gap.

Karen Kerrigan is president & CEO of the Small Business & Entrepreneurship Council, a research and advocacy group based in Washington, D.C. that works to protect small business and promote entrepreneurship. She is also founder of Women Entrepreneurs, Inc., an association helping women business owners succeed through education, networking and advocacy. Kerrigan can be reached at kkerrigan@sbecouncil.org.

Click here to visit FOXBusiness.com's Small Business Center.