— Ch. 1 · The Economics Of Crime —
Tax evasion.
~6 min read · Ch. 1 of 6
In 1968, Nobel laureate economist Gary Becker first theorized the economics of crime. This work laid the foundation for understanding why people break tax laws. Two years later, authors Michael G. Allingham and Agnar Sandmo produced a specific economic model of tax evasion in 1972. Their paper appeared in the Journal of Public Economics as Income Tax Evasion: A Theoretical Analysis. The model deals with the evasion of income tax, which remains the main source of tax revenue in developed countries today. They analyzed the decision of a risk-averse agent who maximizes utility by choosing an optimal level of undeclared income. According to their findings, the level of evasion depends on detection probability and punishment levels provided by law. It also relies heavily on the level of risk aversion held by the individual. Later studies pointed out limitations of this early model. Researchers highlighted that individuals are more likely to comply when they believe tax money is used appropriately. People also tend to follow rules if they can take part in public decisions. Alternative specifications yield conflicting results concerning both signs and magnitudes of variables believed to affect tax evasion. Empirical work is required to resolve these theoretical ambiguities. Income tax evasion appears to be positively influenced by high tax rates and unemployment levels. Dissatisfaction with government performance also drives higher evasion numbers. The U.S. Tax Reform Act of 1986 appears to have reduced tax evasion in the United States significantly.
Measuring The Missing Money
The Internal Revenue Service defines the gross tax gap as the difference between true tax liability for a given year and taxes actually remitted on time. This gap comprises three distinct components: the non-filing gap, the underreporting gap, and the underpayment or remittance gap. Voluntary tax compliance in the U.S. sits at approximately 85% of taxes actually due. This leaves a gross tax gap of about 15%. Estimates from the IRS show the 2001 tax gap reached $345 billion. By 2006, that figure had grown to $450 billion. A study of the 2008 tax gap found a range between $450 billion and $500 billion. Unreported income was estimated at about $2 trillion during that period. Researchers concluded that 18 to 19 percent of total reportable income was not being properly reported to the IRS. The tax gap grows mainly because of two factors. Lack of enforcement on one hand creates space for non-compliance. Lack of compliance on the other hand stems from the foundation that paying taxes is costly for individuals and firms. Tax filling and bureaucracy create financial burdens. Hence not paying taxes would be more economical in their opinion. Corruption by tax officials makes it difficult to control evasion effectively.