Tax evasion

Tax evasion, also known as tax fraud, is an illegal attempt to avoid paying taxes.

This activity involves individuals, corporations, or trusts deliberately misrepresenting their financial affairs to tax authorities. By doing this, they try to reduce their tax liability, which is the total amount of money they legally owe to the state. This is different from tax avoidance. Tax avoidance is the legal use of tax laws to reduce a tax burden. While both aim to subvert a tax system, avoidance is considered lawful within self-creating systems. Evasion, however, relies on dishonest actions like reporting less income or profits than were actually earned.

There are many specific ways that people and businesses commit tax evasion. Some may overstate their deductions to make it look like they have less money to tax. Others might use bribes to influence officials or hide money in secret locations. In international trade, importers often attempt to evade customs duties. They might use under-invoicing, which means listing a lower price on paperwork than what was actually paid. They might also use misdeclaration, where they describe a product incorrectly to match a lower tax rate. Smuggling is another method used to avoid customs duties entirely by moving goods through covert transport without making any official declarations.

Consumption taxes, such as value-added tax (VAT) or sales taxes, are also targets for evasion. In the second half of the 20th century, VAT became a common modern consumption tax globally. Producers might evade this tax by under-reporting the total amount of sales they make to consumers. In federal countries like the United States and Canada, people may also try to avoid local sales taxes. This often happens when consumers buy items in a jurisdiction with lower tax rates. Because liberal democracies often have few border controls between internal regions, it is difficult to enforce these rules on low-value goods carried in private vehicles. However, governments still try to collect sales tax on high-value items like cars.

Economists have spent decades trying to understand the mechanics of why people choose to evade taxes. In 1968, Nobel laureate Gary Becker developed theories regarding the economics of crime. Building on this, Michael G. Allingham and Agnar Sandmo created an economic model in 1972. Their model focused on the evasion of income tax, which is a primary revenue source for developed nations. They studied how a risk-averse person decides how much income to keep undeclared. Their research suggested that evasion levels depend on the probability of being detected, the severity of legal punishment, and how much a person dislikes risk. Later studies added that people are more likely to comply if they believe tax money is used appropriately.

Recent research has provided specific data on how wealth relates to tax evasion. A 2017 study by Alstadsæter and colleagues used leaked data and random audits to find significant patterns. They concluded that the occurrence of tax evasion rises sharply as the amount of wealth increases. Specifically, the richest 0.01% of people are about 10 times more likely to engage in tax evasion than the average person. These wealthy individuals may evade as much as 25% of their required taxes. In the United States, the Treasury Department has noted that the top 5% of earners are responsible for over half of all unpaid taxes.

Tax authorities use the term "tax gap" to measure the extent of unpaid taxes. The gross tax gap is the difference between the true tax liability and the taxes actually paid on time. This gap is made up of three parts: the non-filing gap, the underreporting gap, and the underpayment gap. In the U.S., voluntary compliance is approximately 85%, leaving a gross tax gap of about 15%. This gap grows due to two main factors: a lack of enforcement and a lack of compliance. Enforcement is often difficult because it is very costly for the government to enforce taxation laws. Compliance is also difficult because filing taxes and managing bureaucracy can be costly for individuals and firms.

Governments use various strategies to combat these illegal activities and increase revenue. Some countries have explored the privatization of tax enforcement to increase efficiency. In the United Kingdom, the agency HMRC set a goal to collect £18 billion in revenue by 2015 through crackdowns. In 2010, they also ran a voluntary amnesty program for professionals, which raised £500 million. Historically, some governments used "tax farming," where private entities collected revenue in exchange for a lump sum. However, this system was prone to abuse by collectors seeking profit. In fact, abuses by tax farmers were a primary cause of the French Revolution.

To prevent fraud in international shipping, some governments use pre-shipment inspection agencies. These agencies, such as Cotecna, work to prevent evasion of customs duties through under-invoicing or misdeclaration. Despite these efforts, corruption by tax officials remains a major obstacle. Corrupt officials may accept bribes to refrain from reporting instances of evasion. This makes it much harder for tax administrations to control the flow of money. Ultimately, the level of evasion in a society is tied to the efficiency of its administration and the perceived fairness of the social exchange between taxpayers and the state.