The era of America's tax evasion problem may be coming to a close
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Resourceful taxpayers have historically searched for ways to cheat on their taxes. Some have reported fictitious children as dependents, while others have hidden income in offshore accounts. Many more have simply failed to report all of their income or have over-claimed deductions and credits, and still others have not even filed tax returns.

These taxpayer derelictions have come at a steep cost. The IRS regularly estimates a “tax gap,” or the difference between what taxpayers are legally required to pay and what they actually pay. The agency’s most recent study found that taxpayers were $458 billion in annual arrears, which is a dollar figure approximately equal to the federal government’s annual budget deficit.

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But the era of significant noncompliance may be coming to an end. There are three reasons for cautious optimism. First, due to the growing use of credit cards, debit cards, and smartphone applications, cash is being dethroned as the medium through which the majority of economic transactions are conducted. Because of its ability to hide transactions, cash has traditionally played a pivotal role in the underground economy, and, by extension, it has been a major contributing factor to the tax gap.

 

Yet, over the last three decades, electronic payment methods have been gradually eclipsing cash use, a trend that is expected to continue to grow. A serendipitous benefit of electronic payment methods is that they always leave an indelible electronic trace, making their use virtually impossible to hide.

Second, due to information accessibility, hiding large sums of income is becoming increasingly difficult. In this day and age, no electronic data is inaccessible. Think otherwise? Just ask the taxpayers who had “hidden” Swiss bank accounts at UBS when one of its employees, Bradley Birkenfeld, downloaded all account holders’ information onto a flash drive and hand-delivered it to the U.S. Department of Justice.

Furthermore, due to the Foreign Account Tax Compliance Act, which mandates that foreign banks disclose their U.S. investors, lest all of their investors endure mandatory tax withholding on their U.S. investments, as well as the entry into several new bilateral tax treaties, which require the exchange of bank information, it has become increasingly difficult for taxpayers to hide assets overseas.

Third, over the past century there has been a huge shift in the labor market, which has marginalized the prevalence of small businesses. When the Tax Code was enacted in 1913, small businesses were the backbone of the nation’s economy. This is no longer the case. The U.S. Census Bureau reports that “very small businesses” comprise 17.6 percent of the economy. While the transition from small “mom-and-pop” operations to mega-size business enterprises has many implications, a critical one has been enhanced tax compliance.

The reason is simple. In a small shop, the opportunity for collusion is vast as evidence, the IRS reports a dismal 56.7 percent overall tax compliance rate for “small business” taxpayers. In contrast, large companies must withhold employee income taxes, leaving minimal opportunity for taxpayer shenanigans, and shareholders of large public companies demand that every dollar be accounted for, again significantly minimizing the opportunity for cheating.

These trends a declining use of cash, the increasing accessibility of information, and a shifting labor market toward large enterprises will likely contribute to a shrinking tax gap. This has several important policy implications. From the standpoint of the government, the extra tax revenues from a declining tax gap means that politicians will be better positioned to help close the nation’s deficit, reduce taxes, or increase government spending.

Greater tax compliance will also lead to shifts in labor markets, with corresponding effects on prices, wages, and the distribution of income. Finally, the IRS will no longer have to focus on ensuring tax compliance, and so could redirect its limited resources on better educating taxpayers, prosecuting those perpetrating identity theft, and detecting those tax practitioners who are derelict in their duties.

Of course, it is unlikely that the next IRS tax gap study will show that all tax cheating has been eliminated. After all, the financial carrot to shortchange the government always looms large, the IRS still needs adequate funding to fulfill its oversight mission, and Congress has to simplify the Tax Code so that there is less mistaken tax noncompliance.

Consider, too, the fact that advances in technology may actually increase the possibility for tax evasion, such as the use of virtual currencies like bitcoin or the use of devices like “zappers.” Finally, globalization may make it easier to hide some forms of income and, furthermore, one should never underestimate the efforts that some taxpayers will make to devise new schemes to hide their income.

Nevertheless, there are strong forces that are working, and will continue to work, to diminish the tax gap. Eventually, the tax gap may well become a thing of the past.

Jay Soled is director of the Master of Accountancy in Taxation at Rutgers University.

James Alm is a professor and chair of the Economics Department at Tulane University.


The views expressed by contributors are their own and are not the views of The Hill.