28 March 2021   Leave a comment

The National Bureau of Economic Research has published a study on tax evasion by high-income individuals in the US. This topic is particularly difficult to study since there a myriad number of legal tactics to disguise income from the Internal Revenue Service. The study does not suggest that low-income individuals do not try to disguise income, but acknowledges that the rewards for evasion are considerably higher for the wealthy:

“The model allows a taxpayer to adopt some costly form of tax evasion that is unlikely to be discovered
on audit at some cost. We show that adoption of such an evasion technology is likely to be concentrated
at the top of the income distribution for two reasons. First, high-income taxpayers have a greater demand for sophisticated evasion strategies that reduce the probability of detection if (i) the desired rate of evasion
does not become trivial at large incomes, and (ii) the cost of adopting becomes a trivial share of income at
large incomes. This is true even holding the probability of audit by income fixed. Second, overall audit rates
and scrutiny of tax returns are substantially higher at the top than at the bottom of the distribution, making
evasion that is less likely to be detected and corrected on audit more attractive at the top. We can also reinterpret the model to think about situations where the outcome of an audit, if it occurs, is uncertain. With
this interpretation, for the same reasons as before, we show that high-income people are then more likely
to adopt positions in the ‘gray area’ between legal avoidance and evasion.”

The techniques used include placing money in offshore accounts that disguise the owners of wealth, “pass-through” corporations that are exempt from corporate taxes, and by a variety of legal accounting tricks that make it difficult for the IRS to follow the money.

It is important to understand that these techniques are generally legal reflecting the bias of the tax code to favor the rich more than the poor. Additionally, the ability and willingness of the IRS to audit high-income individuals is constrained by a lack of financial support from the Congress. As reported in The Huffington Post:

“The percentage of income tax evasion generally increases with the income category, the study found. Taxpayers in the bottom half of income categories evade taxes on around 7% of their income. Taxpayers in the top fifth evade taxes on 10% of their income, with the richest 5% avoiding taxes on at least 20% of income.

“The average annual income of the top 1% of earners is approximately $1.7 million. They collect some 20% of the money earned annually in the nation, according to the Pew Research Center.

“Even as high earners are dodging taxes, IRS audits of the wealthy have plunged, another recent study has found. Audits of those reporting incomes over $1 million fell from nearly 50,000 in 2012 to just over 11,000 last year — even as the number of millionaires skyrocketed.”

This bias aggravates the problem of economic inequality in the US which is the worst of all the rich countries. The Pew Research Center documents how the situation of inequality has significantly worsened over time:

“The wealth gap between America’s richest and poorer families more than doubled from 1989 to 2016, according to a recent analysis by the Center. Another way of measuring inequality is to look at household wealth, also known as net worth, or the value of assets owned by a family, such as a home or a savings account, minus outstanding debt, such as a mortgage or student loan.

“In 1989, the richest 5% of families had 114 times as much wealth as families in the second quintile (one tier above the lowest), at the median $2.3 million compared with $20,300. By 2016, the top 5% held 248 times as much wealth at the median. (The median wealth of the poorest 20% is either zero or negative in most years we examined.)”

Posted March 28, 2021 by vferraro1971 in World Politics

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