Tax evasion

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Not to be confused with tax avoidance.

Tax evasion is the illegal evasion of taxes by individuals, corporations and trusts. Tax evasion often entails taxpayers deliberately misrepresenting the true state of their affairs to the tax authorities to reduce their tax liability and includes dishonest tax reporting, such as declaring less income, profits or gains than the amounts actually earned, or overstating deductions. Tax evasion is an activity commonly associated with the informal economy. One measure of the extent of tax evasion (the "tax gap") is the amount of unreported income, which is the difference between the amount of income that should be reported to the tax authorities and the actual amount reported.

In contrast, tax avoidance is the legal use of tax laws to reduce one's tax burden. Both tax evasion and avoidance can be viewed as forms of tax noncompliance, as they describe a range of activities that intend to subvert a state's tax system, although such classification of tax avoidance is not indisputable, given that avoidance is lawful, within self-creating systems.[1]

Economics of tax evasion[edit]

The ratio of German assets in tax havens in relation to the total German GDP.[2] Havens in countries with tax information sharing allowing for compliance enforcement have been in decline. The "Big 7" shown are Hong Kong, Ireland, Lebanon, Liberia, Panama, Singapore, and Switzerland.

In 1968, Nobel laureate economist Gary Becker first theorized the economics of crime,[3] on the basis of which authors M.G. Allingham and A. Sandmo produced, in 1972, an economic model of tax evasion. This model deals with the evasion of income tax, the main source of tax revenue in developed countries. According to the authors, the level of evasion of income tax depends on the level of punishment provided by law.[4]

The literature's theoretical models are elegant in their effort to identify the variables likely to affect non-compliance. Alternative specifications, however, yield conflicting results concerning both the signs and magnitudes of variables believed to affect tax evasion. Empirical work is required to resolve the theoretical ambiguities. Income tax evasion appears to be positively influenced by the tax rate, the unemployment rate, the level of income and dissatisfaction with government.[5] The U.S. Tax Reform Act of 1986 appears to have reduced tax evasion in the United States.[citation needed]

Evasion of customs duty[edit]

Customs duties are an important source of revenue in developing countries. Importers purport to evade customs duty by (a) under-invoicing and (b) misdeclaration of quantity and product-description. When there is ad valorem import duty, the tax base can be reduced through underinvoicing. Misdeclaration of quantity is more relevant for products with specific duty. Production description is changed match a H. S. Code commensurate with a lower rate of duty.[6]

Smuggling[edit]

Smuggling is importation or exportation of foreign products by illegal means. Smuggling is resorted to for total evasion of customs duties, as well as for the importation of contraband. A smuggler does not have to pay any customs duty since smuggled products are not routed through customs-tax compliant customs ports, and are therefore not subjected to declaration and, by extension, to the payment of duties and taxes.[6]

Evasion of value added tax (VAT) and sales taxes[edit]

Ten countries with the largest absolute levels of tax evasion per year. It is estimated that tax evasion amounts to 5 percent of the global economy.[7]

During the second half of the 20th century, value added tax (VAT) emerged as a modern form of consumption tax throughout the world, with the notable exception of the United States. Producers who collect VAT from consumers may evade tax by under-reporting the amount of sales.[8] The US has no broad-based consumption tax at the federal level, and no state currently collects VAT; the overwhelming majority of states instead collect sales taxes. Canada uses both a VAT at the federal level (the Goods and Services Tax) and sales taxes at the provincial level; some provinces have a single tax combining both forms.

In addition, most jurisdictions which levy a VAT or sales tax also legally require their residents to report and pay the tax on items purchased in another jurisdiction. This means that consumers who purchase something in a lower-taxed or untaxed jurisdiction with the intention of avoiding VAT or sales tax in their home jurisdiction are technically breaking the law in most cases. This is especially prevalent in federal countries like Nigeria, US and Canada where sub-national jurisdictions charge varying rates of VAT or sales tax. In Nigeria, for example, some federated states enforce VAT on each item of goods sold by traders. The price must be clearly stated and the VAT shown separately from the basic price. If the trader does not comply (e.g. by including the VAT in the price of the goods) this is punishable as an attempt to siphon the VAT.

In liberal democracies, a fundamental problem with inhibiting evasion of local sales taxes is that liberal democracies, by their very nature, have few (if any) border controls between their internal jurisdictions. Therefore, it is not generally cost-effective to enforce tax collection low-value goods carried in private vehicles from one jurisdiction to another with a different tax rate. However, sub-national governments will normally seek to collect sales tax on high-value items such as cars.[9]

Dennis Kozlowski is particularly notable figure for his alleged evasion of sales tax. What started as an investigation into Kozlowski's failure to declare art purchases for the purpose of evading New York state sales taxes eventually led to Kozlowski's conviction and incarceration on more serious charges related to the misappropriation of funds during his tenure as CEO of TYCO International.

Government response[edit]

The level of evasion depends on a number of factors, including the amount of money a person or a corporation possesses. Efforts to evade income tax decline when the amounts involved are lower. The level of evasion also depends on the efficiency of the tax administration. Corruption by tax officials make it difficult to control evasion. Tax administrations use various means to reduce evasion and increase the level of enforcement: for example, privatization of tax enforcement,[6] tax farming,[10][11] In 2011, HMRC stated that it would continue to crack down on tax evasion, with the goal of collecting £18 billion in revenue before 2015.[12] In 2010, HMRC began a voluntary amnesty program that targeted middle-class professionals and raised £500 million.[13]

Corruption by tax officials[edit]

Corrupt tax officials co-operate with the taxpayers who intend to evade taxes. When they detect an instance of evasion, they refrain from reporting it in return for bribes. Corruption by tax officials is a serious problem for the tax administration in many[which?] less developed countries.

Level of evasion and punishment[edit]

Tax evasion is a crime in almost all developed countries, and the guilty party is liable to fines and/or imprisonment. In Switzerland, many acts that would amount to criminal tax evasion in other countries are treated as civil matters. Dishonestly misreporting income in a tax return is not necessarily considered a crime. Such matters are handled in the Swiss tax courts, not the criminal courts.[citation needed]

In Switzerland, however, some tax misconduct is criminal, for example, deliberate falsification of records. Moreover, civil tax transgressions may give rise to penalties. It is often considered that the extent of evasion depends on the severity of punishment for evasion.

Privatization of tax enforcement[edit]

A "Lion's Mouth" postbox for anonymous denunciations at the Doge's Palace in Venice, Italy. Text translation: "Secret denunciations against anyone who will conceal favors and services or will collude to hide the true revenue from them."

Professor Christopher Hood first[citation needed] suggested privatization of tax enforcement to control tax evasion more efficiently than a government department would.,[14] and some governments have adopted this approach. In Bangladesh, customs administration was partly privatized in 1991.[6]

Abuse by private tax collectors (see tax farming below) has on occasion led to revolutionary overthrow of governments who have outsourced tax administration.

Tax farming[edit]

Further information: Tax farming

Tax farming is an historical means of collection of revenue. Governments received a lump sum in advance from a private entity, which then collects and retains the revenue and bears the risk of evasion by the taxpayers. It has been suggested that tax farming may reduce tax evasion in less developed countries.[10]

This system may be liable to abuse by the "tax-farmers" seeking to make a profit, without being subject to political constraints. Abuses by tax farmers (together with a tax system that exempted the aristocracy) were a primary reason for the French Revolution that toppled Louis XVI.

PSI agencies[edit]

Pre-shipment Agencies like SGS, Cotecna etc. are employed to prevent evasion of customs duty through under-invoicing and misdeclaration. However, in the recent times, allegations have been lodged that PSI agencies have actively cooperated with the importers in evading customs duties. Authority in Bangladesh has found Cotecna, a PSI agency of Swiss origin, guilty of complicity with the importers for evasion of customs duties on a huge scale.[15] The same company Cotecna was implicated for bribing Pakistan's prime minister Benazir Bhutto for securing contract for importation by Pakistani importers. She and her husband were sentenced both in Pakistan and Switzerland.[16]

United States[edit]

US Federal Revenue Lost
to Tax Evasion[17]
YearRevenue lost
(US$ billion)
2010305
2009304
2008357
2007376
2006350
2005314
2004272
2003257
2002269
2001290
Total revenue lost:$3.09 trillion

In the United States, tax evasion is the purposeful, illegal attempt to evade the assessment or the payment of a tax imposed by federal law. Conviction of tax evasion may result in fines and imprisonment.[18]

The Internal Revenue Service (IRS) has identified small businesses and sole proprietors as the largest contributors to the tax gap between what Americans owe in federal taxes and what the federal government receives. Small businesses and sole proprietorships contribute to the tax gap because there are few ways for the government to know about skimming or non-reporting of income without mounting significant investigations.

The most common means of tax evasion is overstatement of charitable contributions, particularly church donations.[19]

Estimates of lost government revenue[edit]

In the United States, the IRS estimate of the 2001 tax gap was $345 billion.[20] For 2006, the tax gap was estimated to be $450 billion.[20] A more recent study estimates the 2008 tax gap in the range of $450–$500 billion, and unreported income to be approximately $2 trillion.[21] Therefore, 18-19 percent of total reportable income is not properly reported to the IRS.[21]

See also[edit]

References[edit]

  1. ^ Michael Wenzel (2002). The Impact of Outcome Orientation and Justice Concerns on Tax Compliance (PDF). Journal of Applied Psychology. pp. 4–5. "When taxpayers try to find loopholes with the intention to pay less tax, even if technically legal, their actions may be against the spirit of the law and in this sense considered noncompliant." 
  2. ^ Shafik Hebous (2011). "Money at the Docks of Tax Havens: A Guide". CESifo Working Paper Series No. 3587, p. 9. 
  3. ^ Gary Becker (1968). "Crime and Punishment: An Economic Approach" (PDF). The Journal of Political Economy 76: 169–217. doi:10.1086/259394. 
  4. ^ Allingham, M. G. and A. Sandmo [1972] ‘Income Tax evasion: A Theoretical Analysis’, Journal of Public Economics, Vol.1, 1972, p.323-38.
  5. ^ Cebula, Richard; Feige, Edgar L. "America’s Underground Economy: Measuring the Size, Growth and Determinants of Income Tax Evasion in the U.S". Ideas.repec.org. 
  6. ^ a b c d Chowdhury, F. L. (1992) Evasion of Customs Duty in Bangladesh, unpublished MBA dissertation, Graduate School of Management, Monash University, Australia.
  7. ^ Reuters http://blogs.reuters.com/david-cay-johnston/2011/12/13/wheres-the-fraud-mr-president/ |url= missing title (help). 
  8. ^ Spiro, Peter S. (2005), "Tax Policy and the Underground Economy," in Christopher Bajada and Friedrich Schneider, eds., Size, Causes and Consequences of the Underground Economy (Ashgate Publishing).
  9. ^ Tomášková, Eva (2008). "Tax Evasion in the Czech Republic - In: A Brief Introduction to Czech Law. Rincon: The American Institute for Central European Legal Studies (AICELS) 2008. p. 111 - 121 ISBN 978-0-692-00045-8" (PDF). 
  10. ^ a b Stella, Peter (1993). "Tax Farming: A Radical Solution for Developing Country Tax Problems?". IMF Staff Papers 40 (1): 217–225. JSTOR 3867383.  edit
  11. ^ Alam. D (1999) Introduction of PSI system in Bangladesh: Facts and Documents, Desh Prokashon, Dhaka.
  12. ^ "Watch out, the taxman's about: HMRC ordered to bring in £18bn in government crackdown". Mail Online (London: dailymail.co.uk). March 17, 2011. Retrieved August 12, 2011. 
  13. ^ Russell, Jonathan (June 10, 2011). "HMRC opens 16 criminal cases over tax evasion". The Telegraph (London: telegraph.co.uk). Retrieved August 12, 2011. 
  14. ^ Hood, C. (1986) Privatizing UK tax Law Enforcement?, Public Administration, Vol. 64, Autumn, 1986, p. 319-33.
  15. ^ NBR show Age
  16. ^ Langley, Alison (6 August 2003). "Pakistan: Bhutto Sentenced In Switzerland". New York Times. 
  17. ^ http://www.ourfiscalsecurity.org/storage/infographic_FRI_D5.pdf[dead link]
  18. ^ 26 U.S.C. § 7201.
  19. ^ Sabatini, Patricia (25 March 2007). "Tax Cheats Cost U.S. hundreds of billions". Pittsburgh Post-Gazette. 
  20. ^ a b "Tax Gap for Tax Year 2006 Overview Jan. 6, 2012". U.S. Internal Revenue Service. Retrieved 2012-06-14. 
  21. ^ a b Cebula, Richard; Feige, Edgar. "America’s Underground Economy: Measuring the Size, Growth and Determinants of Income Tax Evasion in the U.S". Ideas.repec.org. 

External links[edit]

United States