New Academic Study Confirms Previous IMF Analysis, Shows that Lower Tax Rates Are the Best Way to Reduce Tax Evasion
Leftists want higher tax rates and they want greater tax compliance. But they have a hard time understanding that those goals are inconsistent.
Simply stated, people respond to incentives. When tax rates are punitive, folks earn and report less taxable income, and vice-versa.
- When tax rates increase, sometimes they engage in tax avoidance, lowering their tax liabilities legally.
- When tax rates change, sometimes they choose to alter their levels of work, saving, and investment.
- And when tax rates go up, sometimes they resort to illegal steps to protect themselves from the tax authority.
In a previous post, I quoted an article from the International Monetary Fund, which unambiguously concluded that high tax burdens are the main reason people don’t fully comply with tax regimes.
Macroeconomic and microeconomic modeling studies based on data for several countries suggest that the major driving forces behind the size and growth of the shadow economy are an increasing burden of tax and social security payments… The bigger the difference between the total cost of labor in the official economy and the after-tax earnings from work, the greater the incentive for employers and employees to avoid this difference and participate in the shadow economy. …Several studies have found strong evidence that the tax regime influences the shadow economy.
Indeed, it’s worth noting that international studies find that the jurisdictions with the highest rates of tax compliance are the ones with reasonable tax systems, such as Hong Kong, Switzerland, and Singapore.
Now there’s a new study confirming these findings. Authored by two economists, one from the University of Wisconsin and the other from Jacksonville University, the new research cites the impact of tax burdens as well as other key variables.
Here are some key findings from the study.
According to the results provided in Table 2, the coefficient on the average effective federal income tax variable (AET) is positive in all three estimates and statistically significant for the overall study periods (1960-2008) at beyond the five percent level and statistically significant at the one percent level for the two sub-periods (1970-2007 and 1980-2008). Thus, as expected, the higher the average effective federal income tax rate, the greater the expected benefits of tax evasion may be and hence the greater the extent of that income tax evasion. This finding is consistent with most previous studies of income tax evasion using official data… In all three estimates, [the audit variable] exhibits the expected negative sign; however, in all three estimates it fails to be statistically significant at the five percent level. Indeed, these three coefficients are statistically significant at barely the 10 percent level. Thus it appears the audit rate (AUDIT) variable, of an in itself, may not be viewed as a strong deterrent to federal personal income taxation [evasion].
Translating from economic jargon, the study concludes that higher tax burdens lead to more evasion. Statists usually claim that this can be addressed by giving the IRS more power, but the researchers found that audit rates have a very weak effect.
The obvious conclusion, as I’ve noted before, is that lower tax rates and tax reform are the best way to improve tax compliance – not more power for the IRS.
Incidentally, this new study also finds that evasion increases when the unemployment rate increases. Given his proposals for higher tax rates and his poor track record on jobs, it almost makes one think Obama is trying to set a record for tax evasion.
The study also finds that dissatisfaction with government is correlated with tax evasion. And since Obama’s White House has been wasting money on corrupt green energy programs and a failed stimulus, that also suggests that the Administration wants more tax evasion.
Indeed, this last finding is consistent with some research from the Bank of Italy that I cited in 2010.
…the coefficient of public spending inefficiency remains negative and highly significant. …We find that tax morale is higher when the taxpayer perceives and observes that the government is efficient; that is, it provides a fair output with respect to the revenues.
And I imagine that “tax morale” in the United States is further undermined by an internal revenue code that has metastasized into a 72,000-page monstrosity of corruption and sleaze.
On the other hand, tax evasion apparently is correlated with real per-capita gross domestic product. And since the economy has suffered from anemic performance over the past three years, that blows a hole in the conspiratorial theory that Obama wants more evasion.
All joking aside, I’m sure the President wants more tax compliance and more prosperity. And since I’m a nice guy, I’m going to help him out. Mr. President, this video outlines a plan that would achieve both of those goals.
Given his class-warfare rhetoric, I’m not holding my breath in anticipation that he will follow my sage advice.
The IRS Can’t Overrule the Supreme Court
Since the foundational administrative law case of Chevron v. Natural Resources Defense Council (1984), courts have given significant deference to executive agency interpretations of federal law. United States v. Home Concrete & Supply tests whether there are any meaningful limits on such deference.
The case involves a group of taxpayers who initiated a number of transactions designed to reduce their tax liability by allowing a financial entity they created, Home Concrete, to increase its tax basis and reduce its taxable gain from the sale of certain assets. In June 2003, the IRS ruled that the taxpayers’ use of Home Concrete in this way was improper and issued an adjustment to their tax return (requiring payment of back-taxes). Having missed the standard three-year limit for such actions, however, the IRS argued that the adjustment was timely under a tax-code provision that extends the statute of limitations to six years if the taxpayer “omits from gross income an amount properly includible therein which is in excess of 25 percent of the amount of gross income stated in the return.”
Despite the Supreme Court’s having long ago held otherwise, Colony v. Commissioner of Internal Revenue (1956), the IRS argues that an overstatement of basis qualifies as an omission under that tax provision. Further, during the course of this litigation, the Treasury Department issued a new regulation “clarifying” the provision in a way that supports the IRS’s argument. The IRS now argues that this new regulation is controlling and should be retroactively applied to Home Concrete’s 1999 returns.
After (mostly) winning at the district court, the IRS lost before the Fourth Circuit and asked the Supreme Court to review the case—which involves one of many similar applications of the relevant tax provisions. The Court took the case and now Cato has joined the National Federation of Independent Business on an amicus brief supporting the taxpayers, arguing that sanctioning this sort of ad hoc rule-making would undermine the rule of law and the separation of powers.
We note that “[t]he government’s position is that this regulation is due judicial deference” but the Supreme Court has “consistently held that where a statute has an unambiguous meaning, an agency’s contrary interpretation is not entitled to deference.” As Judge J. Harvie Wilkinson noted in his Fourth Circuit concurrence, “agencies are not a law unto themselves” and the government’s position in this case “seems to [be] something of an inversion of the universe and to pass the point where the beneficial application of agency expertise gives way to a lack of accountability and a risk of arbitrariness.”
In deciding Chevron, the Supreme Court surely never intended to undermine the very structure of the Republic and unleash an administrative state wholly a law unto itself.
The Supreme Court will hear United States v. Home Cincrete & Supply on January 17.
Obama Has United the World … in Opposition to Bad U.S. Tax Policy
Last year, I came up with a saying that “Bad Government Policy Begets More Bad Government Policy” and labeled it “Mitchell’s Law” during a bout of narcissism.
There are lots of examples of this phenomenon, such as the misguided War on Drugs being a precursor to intrusive, costly, and ineffective money laundering policies.
Or how about government healthcare subsidies driving up the price of healthcare, which then leads politicians to decide that there should be even more subsidies because healthcare has become more expensive.
But if you want a really stark example of Mitchell’s Law, the Internal Revenue Code is littered with examples.
The politicians created a nightmarishly complex tax system, for instance, and then decided that enforcing the wretched system required the erosion of civil liberties and constitutional freedoms.
The latest example of this process involves the Foreign Account Tax Compliance Act, a piece of legislation that was imposed in 2010 because politicians assumed they could collect lots of tax revenue every single year by getting money from so-called tax havens.
Podcast: How States Can Shut Down ObamaCare
Here’s a podcast on how states can shut down ObamaCare.
And here are links to additional material, including an op-ed that provides an overview, a blog post about Sen. Orrin Hatch (R-UT) getting involved, a blog post on how presidential candidates could get involved, and finally a blog post on what the Obama administration has to say about all this.
ObamaCare’s Premium-Assistance Glitch: Orrin Hatch Edition
The Senate Finance Committee’s ranking member is not amused.
A Weak Defense of an Illegal Fix to an ObamaCare Glitch
In this November 16 op-ed, Jonathan Adler and I explain how the Obama administration is trying to save ObamaCare (“the Affordable Care Act”) by creating tax credits and government outlays that Congress hasn’t authorized. (The administration describes this “premium assistance” solely as tax credits.) This week, the administration tried to reassure everybody that no, they’re not doing anything illegal.
Here’s how IRS commissioner Douglas H. Shulman responded to a letter from two dozen members of Congress (emphasis added):
The statute includes language that indicates that individuals are eligible for tax credits whether they are enrolled through a State-based Exchange or a Federally-facilitated Exchange. Additionally, neither the Congressional Budget Office score nor the Joint Committee on Taxation technical explanation of the Affordable Care Act discusses excluding those enrolled through a Federally-facilitated Exchange.
And here is how HHS tried to dismiss the issue (emphasis added):
The proposed regulations issued by the Treasury Department, and the related proposed regulations issued by the Department of Health and Human Services, are clear on this point and supported by the statute. Individuals enrolled in coverage through either a State-based Exchange or a Federally-facilitated Exchange may be eligible for tax credits. …Additionally, neither the Congressional Budget Office score nor the Joint Committee on Taxation technical explanation discussed limiting the credit to those enrolled through a State-based Exchange.
These statements show that the administration’s case is weak, and they know it.
When government agencies say that a statute indicates they are allowed to do X, or that their actions are supported by that statute, it’s a clear sign that the statute does not explicitly authorize them to do what they’re trying to do. If it did, they would say so. (A Treasury Department spokeswoman offers a similarly worded rationale.)
In our op-ed, Adler and I explain why the statutory language to which these agencies refer does not create the sort of ambiguity that might enable the IRS to get away with offering premium assistance in federal Exchanges anyway. (Nor does the fact that the CBO and the JCT misread portions of this 2,000-page law create such ambiguity.) That’s because there is no ambiguity in that language. There is only a desperate search for ambiguity because the law clearly says what supporters don’t want it to say.
Finally, the fact that these two statements are so similar shows that the administration considers this glitch to be a serious problem and wants everyone on the same page.
Washington & Lee University law professor Timothy Jost is an ObamaCare supporter and a leading expert on the law. He is also too honest for government service, for he has acknowledged that ObamaCare “clearly” does not authorize premium assistance in federal Exchanges, and that it is only “arguabl[e]” that federal courts will let the administration get away with offering it. (Again, in our op-ed, Adler and I explain why that argument falls flat.)
After reading the administration’s statements, Adler writes, ”If that’s all they got, they should be worried.”
FATCA Law Is a Nightmare for Cross-Border Economic Activity
One of the tax increases buried in Obamacare was an onerous and intrusive “1099″ scheme that would have required businesses to collect tax identification numbers for just about any vendor and then send paperwork to the IRS whenever they did more than $600 of business.
- Send one of your sales people to New York for a couple of nights? They would have to get the tax ID for the hotel and submit a form to the IRS.
- Buy a printer for the office? The printer company would need to provide a tax ID and the purchaser would have to submit a form to the IRS.
- o Have a retirement dinner for somebody in the accounting department? Get the restaurant’s tax ID and submit another form to the IRS.
This system was seen as a nightmare, even leading to rather amusing cartoons mocking the law and showing how it would expand an already abusive IRS. And in a rare fit of common sense, the 1099 requirement was repealed earlier this year.
That’s the good news. The bad news is that an international version of Obamacare’s 1099 scheme also was enacted early last year. But since the burden is largely falling on foreigners, there’s no groundswell among voters to repeal the law — even though it will impose far more damage on the American economy.
Known as the FATCA (the acronym for the Foreign Account Tax Compliance Act), this law was included as a revenue-raising provision to pay for one of Obama’s failed stimulus bills.
But while the bill didn’t create jobs, it has created a giant nightmare for all sorts of people and firms — including foreign financial institutions that may now decide that it’s no longer worth the trouble to invest in America.
What the Tea Party Hath Wrought?
The Internal Revenue Service is investigating campaign donations to groups incorporated under 501(c)(4) of the tax code. Some in the IRS apparently hope to apply gift taxes to the contributions.
Higher taxes on an activity would generally lead to less of that activity, especially if a good substitute exists that is not taxed. In this case, donors could give money to 527 groups. Such donations are exempt from taxation. But 527 groups are subject to disclosure of donors.
The IRS investigations involve tax provisions “that had rarely, if ever, been enforced.” Why now? We do not know. But 501(c)(4) groups played in a important part in the 2010 campaign. As you know, the party in power lost control of the House of Representatives in 2010. With the president’s re-election at stake in 2012, the administration might hope that that less money is available to fund the political speech of its opponents.
The White House has already issued a draft order requiring disclosure of political spending by government contractors. Now these investigations of donors. The IRS effort need not lead to legal complaints to be politically effective. As one expert notes, “The lack of clarity and the potential for not-insignificant taxation on these gifts will cause many of the biggest donors to think twice.”
Many people argue that mandatory disclosure of political spending has few costs and many benefits. Such laws are said to discourage few donors from funding political speech. If that is true, why is the Obama administration so interested in forcing donors out of anonymity?
Perhaps the administration believes deeply in transparency. Or perhaps the administration believes that attacking (no longer anonymous) donors will effectively discourage speech critical of the President in 2012.
The political misuse of the Internal Revenue Service should be a concern of everyone. During the Kennedy, Johnson, and Nixon administrations, presidents and their people decided, as John Dean put it at the time, to “use the available federal machinery to screw our political enemies.” Have we forgotten that history?
President Obama’s Dubious Claims about Incomes of the Top 1% vs. the Bottom 90%
“In the last decade, the average income of the bottom 90 percent of all working Americans actually declined,” Obama said on April 13. “The top 1 percent saw their income rise by an average of more than a quarter of a million dollars each.”
Politi-Fact, partly on the basis of my own research, generously rates the president’s claim as “Half True.”
The truth is that the President’s source, Thomas Piketty and Emmanuel Saez, refer only to pretax, pretransfer income reported on individual tax returns (as opposed to being sheltered inside a corporation or IRA or simply unreported), and they have no data on the bottom 90%. Worst of all, they leave out transfer payments, which amounted to $2.3 trillion last year — 44% as large as all private wages and salaries ($5.2 trillion). The data also excludes refundable tax credits, which added about $170 billion to low and middle incomes in 2009 according to the the Joint Committee on Taxation (the EITC, child credit and Obama’s “making work pay” credit). And the Bureau of Economic Analysis estimates that gross income reported on tax returns is about $1 trillion less than actual income.
As for the top 1%, my research shows that top investors report more capital gains and dividends when those tax rates go down, which is why they paid such a big share of income taxes (up to 40%) in 1997-2000 and 2003-2007. Raise the tax on dividends and capital gains to 23.8%, as Obama hopes to do by 2014, and somebody else would have to pay the taxes now paid by the top 1%. Using income reported to the IRS to measure actual living standards is foolhardy at best.
Senator Rubio, Representative Posey, and other Lawmakers Fighting to Stop Rogue IRS Proposal that Would Drive Investment from U.S. Economy
There hasn’t been much good economic news in recent years, but one bright spot for the economy is that the United States is a haven for foreign investors and this has helped attract more than $10 trillion to American capital markets according to Commerce Department data.
These funds are hugely important for the health of the U.S. financial sector and are a critical source of funds for new job creation and other forms of investment.
This is a credit to the competitiveness of American banks and other financial institutions, but we also should give credit to politicians. For more than 90 years, Congress has approved and maintained laws to attract investment from overseas. As a general rule, foreigners are not taxed on interest they earn in America. Moreover, by not requiring it to be reported to the IRS, lawmakers on Capitol Hill have effectively blocked foreign governments from taxing this U.S.-source income.
This is why it is so disappointing and frustrating that the Internal Revenue Service is creating grave risks for the American economy by pushing a regulation that would drive a significant slice of this foreign capital to other nations. More specifically, the IRS wants banks to report how much interest they pay foreign depositors so that this information can be forwarded to overseas tax authorities.
Yes, you read correctly. The IRS is seeking to abuse its regulatory power to overturn existing law.
Not surprisingly, many members of Congress are rather upset by this rogue behavior.
Senator Rubio, for instance, just sent a letter to President Obama, slamming the IRS and urging the withdrawal of the regulation.
At a time when unemployment remains high and economic growth is lagging, forcing banks to report interest paid to nonresident aliens would encourage the flight of capital overseas to jurisdictions without onerous reporting requirements, place unnecessary burdens on the American economy, put our financial system at a fundamental competitive disadvantage, and would restrict access to capital when our economy can least afford it. …I respectfully ask that Regulation 146097-09 be permanently withdrawn from consideration. This regulation would have a highly detrimental effect on our economy at a time when pro-growth measures are sorely needed.
And here’s what the entire Florida House delegation (including all Democrats) had to say in a separate letter organized by Congressman Posey.
America’s financial institutions benefit greatly from deposits of foreigners in U.S. banks. These deposits help finance jobs and generate economic growth… For more than 90 years, the United States has recognized the importance of foreign deposits and has refrained from taxing the interest earned by them or requiring their reporting. Unfortunately, a rule proposed by the Internal Revenue Service would overturn this practice and likely result in the flight of hundreds of billions of dollars from U.S. financial institutions. …According to the Commerce Department, foreigners have $10.6 trillion passively invested in the U.S. economy, including nearly “$3.6 trillion reported by U.S. banks and securities brokers.” In addition, a 2004 study from the Mercatus Center at George Mason University estimated that “a scaled back version of the rule would drive $88 billion from American financial institutions,” and this version of the regulation will be far more damaging.
Both Texas Senators also have registered their opposition. Senators Hutchison and Cornyn wrote to the Obama Administration earlier this month.
We are very concerned that this proposed regulation will bring serious harm to the Texas economy, should it go into effect. …Forgoing the taxation of deposit interest paid to certain global investors is a long-standing tax policy that helps attract capital investment to the United States. For generations, these investors have placed their funds in institutions in Texas and across the United States because of the safety of our banks. Another reason that many of these investors deposit funds in American institutions is the instability in their home countries. …With less capital, community banks will be able to extend less credit to working families and small businesses. Ultimately, working families and small businesses will bear the brunt of this ill-advised rule. Given the ongoing fragility of our nation’s economy, we must not pursue policies that will send away job-creating capital.We ask you to withdraw the IRS’s proposed REG-14609-09. The United States should continue to encourage deposits from global investors, as our nation and our economy are best served by this policy.
Their dismay shouldn’t be too surprising since their state would be especially disadvantaged. Here are key passages from a story in the Houston Chronicle.
Texas bankers fear Mexican nationals will yank their deposits if the institutions are required to report to the Internal Revenue Service the interest income non-U.S. residents earn. …such a requirement would drive billions of dollars in deposits to other countries from banks in Texas and other parts the country, hindering the economic recovery, bankers argue. About a trillion dollars in deposits from foreign nationals are in U.S. bank accounts, according to some estimates. …The issue is of particular concern to some banks in South Texas, where many Mexican nationals have moved deposits because they don’t feel their money is safe in institutions in Mexico. …”This proposal has caused a wave of panic in Mexico,” said Lindsay Martin, an estate-planning lawyer with Oppenheimer Blend Harrison + Tate in San Antonio. He has received in recent weeks more than a dozen calls from Mexican nationals and U.S.-based financial planners with questions on the rule. …Jabier Rodriguez, chief executive of Pharr-based Lone Star National Bank, said not one Mexican national he has spoken to backs the rule. “Several of them have said if it were to happen, then there’s no reason for us to have our money here anymore,” he said. Many Mexican nationals worry that the data could end up in the wrong hands, jeopardizing their safety. If people in Mexico and some South American nations find out they have a million dollars in an FDIC-insured account in the United States, “their families could be kidnapped,” added Alex Sanchez, president of the Florida Bankers Association.
For those who want more information about this critical issue, here’s a video explaining why the IRS’s unlawful regulation is very bad for the American economy.
Tuesday Links
- Please join us this Thursday, April 21 at 4:00 p.m. Eastern for a book forum and debate on “green energy” policy, following the recent release of the Cato book The False Promise of Green Energy. On Thursday, University of Alabama Professor of Law and Business Andrew P. Morriss (one of the book’s authors) and Center for American Progress Vice President for Energy Policy Kate Gordon will debate the merits of the “green” economic agenda, moderated by Cato Institute Senior Fellow Jerry Taylor. Complimentary registration is required of all attendees by noon TOMORROW, Wednesday, April 20. We hope you can join us in person and for the reception following the event–if you cannot attend in person, we hope you’ll tune in online or on Facebook.
- “Nothing in international law, however, can change the United States Constitution’s procedures for when the United States can go to war — which require the consent of Congress.”
- Nothing says it’s time to convert Medicaid to block grants like letters from 17 governors opposing the idea.
- Nothing would spur economic recovery like a “liberate to stimulate” regulatory agenda.
- Nothing says “failure” like 37,000 dead and climbing.
- Nothing is more complicated and convoluted than the U.S. tax code, which changed 579 times in the last year–more than one change every day:
The IRS: Even Worse Than You Think
Since it is tax-filing season and we all want to honor our wonderful tax system, let’s go into the archives and show this video from last year about the onerous compliance costs of the internal revenue code.
Narrated by Hiwa Alaghebandian of the American Enterprise Institute, the mini-documentary explains how needless complexity creates an added burden – sort of like a hidden tax that we pay for the supposed privilege of paying taxes.
Two things from the video are worth highlighting.
First, we should make sure to put most of the blame on Congress. As Ms. Alaghebandian notes, the IRS is in the unenviable position of trying to enforce Byzantine tax laws. Yes, there are examples of grotesque IRS abuse, but even the most angelic group of bureaucrats would have a hard time overseeing 70,000-plus pages of laws and regulations (by contrast, the Hong Kong flat tax, which has been in place for more than 60 years, requires less than 200 pages).
Second, we should remember that compliance costs are just the tip of the iceberg. The video also briefly mentions three other costs.
- The money we send to Washington, which is a direct cost to our pocketbooks and also an indirect cost since the money often is used to finance counterproductive programs that further damage the economy.
- The budgetary burden of the IRS, which is a staggering $12.5 billion. This is the money we spend to employ an army of tax bureaucrats that is larger than the CIA and FBI combined.
- The economic burden of the tax system, which measures the lost economic output from a tax system that penalizes productive behavior.
The way to fix this mess, needless to say, is to junk the entire tax code and start all over.
I’ve been a big proponent of the flat tax, which would mean one low tax rate, no double taxation of savings, and no corrupt loopholes. But I’m also a big fan of national sales tax proposals such as the Fair Tax, assuming we can amend the Constitution so that greedy politicians don’t pull a bait and switch and impose both an income tax and a sales tax.
But the most important thing we need to understand is that bloated government is our main problem. If we had a limited federal government, as our Founding Fathers envisioned, it would be almost impossible to have a bad tax system. But if we continue to move in the direction of becoming a European-style welfare state, it will be impossible to have a good tax system.
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