In order to combat the negative effects of tax evasion, the Biden administration has made promises to enact policies that would counteract some of the measures the Trump administration took when implementing tax reforms that benefited the wealthy.
Tax avoidance and evasion have become a growing concern for economists and researchers. In a recent paper by the Internal Revenue Service (IRS) and economic researchers from the National Bureau of Economic Research (NBER), it is estimated that, by collecting all unpaid federal income tax from the top 1%, federal revenue could be boosted by about US$175 billion annually.
The authors of the paper include John Guyton and Patrick Langetieg of the IRS Research, Applied Analytics, and Statistics department. Along with Guyton and Langetieg are economic and business professors from the London School of Economics, the University of California, Berkeley and Carnegie Mellon University.
According to the paper, the researchers indicated that the top 1% of households do not report 21% of their income. Approximately 6% of this is undetectable by federal audits and is primarily a result of “sophisticated evasion” strategies including utilizing private businesses and offshore accounts. The report also indicates that tax evasion committed by the wealthy could have a negative effect on the United States’ gross domestic product.
In order to combat the negative effects of tax evasion, the Biden administration has made promises to enact policies that would counteract some of the measures the Trump administration took when implementing tax reforms that benefited the wealthy.
Tax avoidance vs tax evasion
Many of those businesses may not be subject to tax evasion, but rather, tax avoidance. Tax evasion – an illegal and punishable offense – is the act of not paying taxes owed to the federal and state government. Tax evasion is not always deliberate and can happen inadvertently.
When an individual does not report or pay their taxes, the deliberate evasion of taxes is distinguishably different from tax avoidance. However, unintentional mistakes made while filing tax returns can also constitute as illegal tax evasion. Tax avoidance, which incentivizes businesses and individuals to pursue legal methods for reducing taxable income, is different from tax evasion.
However, the line between what is considered evasion and avoidance has grown increasingly thin as businesses and individuals take advantage of ambiguous laws and legal semantics to avoid paying higher taxes.
The tax gap
The standard measure of tax evasion is the “tax gap.” The tax gap, the amount of taxes that are owed but are not paid in a timely or voluntary manner, is measured by the IRS. The IRS collects information on the tax gap by conducting periodic studies that draw on a number of sources.
For example, underreporting of individual income taxes is typically measured by the IRS by collecting information each year from random samples of taxpayers. The IRS has not updated the net tax gap since 2013 when it was estimated to be at US$381 billion between 2011 and 2013.
However, researchers from NBER indicated that the tax gap may not be as accurate as previously thought due to increased measures taken by the top 1% including offshore accounts and technological advancements along with antiquated counter measurements such as random audits.
“We find that detected evasion declines sharply at the very top of the income distribution, with only a trivial amount of evasion detected in the top 0.01%,” the report indicates. “Our analysis uncovers two key limitations of random audits which can account for much of this drop-off: tax evasion through foreign intermediaries (e.g., undeclared foreign bank accounts) and tax evasion via pass-through businesses (e.g., partnerships).”
The report further indicates that while the bottom 99% are often examined with great detail when it comes to measures taken to avoid or evade paying taxes, “up to 35% of the income earned at the top is not comprehensively examined.”
Furthermore, the report indicates that administrative resources are required if the IRS is expected to better detect and deter tax evasion and avoidance. Some suggestions from the researchers include using whistleblowers and employing specialized audits.
Recent administrative resources
In a House panel last week, IRS Commissioner Charles Rettig stated that audit rates for high-income taxpayers have greatly decreased in the past decade because the IRS has undergone significant turnover in staff that would normally examine the returns of wealthy individuals.
“Since 2010, we have lost 15,000 enforcement personnel,” Rettig said. “It is not just a body count of how many people we have in enforcement. We need specialized agents.”
According to some aides within the Biden administration, members of the administration are looking at eliminating a portion of former President Donald Trump’s income-tax cuts that benefited the top 1% of earners.
“Anybody making more than US$400,000 will see a small to a significant tax increase,” Biden said in an interview with ABC News.
While individuals may be concerned that they will have to pay more taxes, Biden stated there won’t be “one single penny in additional federal tax” for those making less than US$400,000 a year.
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