HMRC-HMT Economics of Taxation 2011

Transcription

1 14 December 2011 HMRC-HMT Economics of Taxation Tax Evasion and Compliance

2 Overview... How compliance fits into public economics Tax Evasion and Compliance Background TAG model Interaction models Evidence 2

3 Tax compliance: Questions Fundamental questions about non-compliance How much? What is it? What drives it? The how much? question: simple quantification does it matter? The what is it? question: tax evasion important special case to be distinguished from tax avoidance? several ways of drawing the line between the two The what drives it? question: how to represent non-compliance in an economic model how does tax evasion fit into the economics of taxation? complex relation between the individual taxpayer and society as a whole Begin with numbers 3

4 2001 US Federal Tax Gap ($billion) Underreported nonbusiness income 56 Underreported business income 109 Overreported Offsets to Income & Credits 32 Individual Income Tax 197 Employment Tax 54 Corporation Income Tax 30 Estate and Excise Taxes 5 Total underreporting 285 Nonfiling 27 Total underpayment 34 Gross tax gap 345 Enforced and other late payments -55 Net tax gap (tax not collected) 290 Source: US Department of the Treasury, Internal Revenue Service (2006) 4

5 UK Tax Gap Estimates per cent Value Added Tax (VAT) Excise duties and other indirect taxes Income Tax, National Insurance Contributions, Capital Gains Tax Corporation Tax Other direct taxes Total tax gap Total tax gap Source, HMRC (2011) Tables 1.2, 1.3 bn 5

6 Tax compliance: broader issues Tax gap Lack of information? (McManus and Warren 2006) US, UK evidence is not bad but elsewhere can be scanty Shadow economy broader than tax evasion / avoidance includes other illegal, unobserved actrivities estimates from Schneider and Enste (2000) based on currency demand Sweden 2% 16% Denmark 4.5% 17.5% Norway 1.5% 18% Germany 2% 13.2% United States 3.5% 9.5% Austria 0.5% 7% Switzerland 1% 6.7% Should we find this alarming? definition of shadow economy is not always consistent shadow economy estimates vary enormously according to method difficult to test proposition that change in relationship due to non-compliance 6

7 Greek Greek Public sector and the Public (1) [ + ] [ ] [ + ] [ ] Roman [ + ] [ ] (β, B) (δ, A) (α, D) (γ, C) Roman [ + ] [ ] (β, B) (γ, A) (α, C) (δ, D) Case 1 a large economy? Case 1 equilibrium Case 2 a small economy? Case 2 equilibria Case 1 A large tax-financed public sector may be perceived as desirable (β, B) People will still try to default on taxes Need a policeman Case 2 policeman may still be needed to avoid disaster (δ, D) to avoid inequity (α, C) or (γ, A) 7

8 Agenda Outline main approaches to tax compliance 1 TAG 2 Strategic interaction 3 Social interaction Consider some important variants public goods and the public sector the role of firms Will lay basis for policy lecture Literature overviews: Andreoni et al (1998) Cowell (1990, 2004) Slemrod (2007) Slemrod and Yitzhaki (2002) 8

9 Overview... Risk-taking behaviour and compliance Tax Evasion and Compliance Background TAG model Strategic interaction Social interaction Evidence 9

10 TAG model Standard model is essentially one of Taxpayer As Gambler based on Allingham and Sandmo (1972) The gamble involves a bet with the tax authority Individuals make bets on whether they will be caught concealing income or not reporting at all or working in underground economy Appropriateness relies on a special set of assumptions about motivation of individuals about the way that the government is perceived 10

11 TAG: taxes, penalties, returns Tax payer/evader has true income y is supposed to pay tax on all of this at rate t chooses to conceal an amount e, pays tax on the remainder Tax authority audits: if evader is caught, pays a surcharge s on the evaded tax te perceived probability of this happening is p Parameters determine returns to evasion: consider rate of return to $1 of evasion activity... r = s with probability p r = 1 with probability 1 p expected rate of return is 1 p ps Consumption (disposable income) is a function of: income y and tax rate t random rate of return r evasion choice e c = [1 t] y + rte (a random variable) 11

12 TAG: budget constraint [1 t]y [1 t st]y c" A [1 t]y y c': consumption if not caught c'': consumption if caught A: Payoffs if absolutely honest B: Payoff if blatantly dishonest Consumption possibilities for all e 1 A cut in the surcharge rate s 2 A cut in the tax rate t 3 Increase in income y B c' c' = [1 t] y + te if not audited / convicted c'' = [1 t] y ste if audited and convicted 12

13 TAG: Preferences and beliefs Tax payer has von-neumann Morgenstern preferences gets no intrinsic pleasure from evasion and feels no shame correctly perceives probability of detection p assumes that it is exogenously given Consumer s welfare is expected utility of consumption: Eu(c) = [1 p] u(c' ) + p u(c'' ) Eu(c) = [1 p] u([1 t] y + te) + p u([1 t] y ste) Cardinal utility function u has the usual properties : u c ( ) > 0 (first derivative) u cc ( ) 0 (second derivative) Both u and p determine shape of ICs in (c', c'' )-space curvature of ICs depends on risk aversion u cc ( )/u c ( ) slope of ICs where crosses 45º line is [1 p]/p 13

14 c" Equilibria of the tax-evader 0 A E C B Feasible set A: corner solution (honesty) B: corner solution (dishonesty) C: Interior (partial honesty) E: Expected payoff c' solution depends on tax parameters τ:= (p, s, t) income y personal attributes a e* = e(τ, y, a) E(ru c (c)) 0 if e* = 0 E(ru c (c)) 0 if e* = y E(ru c (c)) = 0 if 0 < e* < y 14

15 Comparative statics Focus on the interior solution what happens to this when tax and enforcement parameters change? do this graphically or analytically differentiate the first-order condition E(ru c (c)) = 0 Effect of increased p: Indifference map rotates For given budget constraint, tangency moves closer to A Effect of increased s: Point B moves down For given utility function, tangency moves closer to A Effect of increased t: assume decreasing absolute risk aversion (DARA) amount invested in a risky asset increases with resources so in this model, given DARA, evasion rises with y but this will also imply that evasion falls with t 15

16 Extending the model Government budget constraint: R R revenue actually raised required target revenue Define economy-wide aggregates aggregate income: Y := y df(y, a) aggregate nominal tax receipts: ty aggregate leakage from evasion: re(τ, y, a) df(y, a) cost of enforcing probability p across economy Φ(p) Composition of revenue R = ty t re(τ, y, a) Φ(p) So budget constraint becomes ty t re(τ, y, a) Φ(p) R But this ignores how the government revenue may be used 16

17 TAG model: Public Sector Taxes are used to pay for a public good z Government budget constraint in this extended model is: R ψz where ψ is the (constant) marginal rate of transformation Individuals benefit from provision of the good but they prefer that someone else pay for it so there is still a motive for tax evasion and expected utility is now Eu(c,z), where u z (c,z) > 0 FOC for an interior maximum is: E(ru c (c,z)) = 0 essentially as before Response of e in this model is much the same for some cases: Surcharge Probability of detection But for the tax rate t we have new insights 17

18 The effect of a rise in the tax rate There are still the conventional income and substitution effects But t also affects amount of public good available Increasing t will: reduce private consumption c increase availability of public good z Desirable to increase t? depends on amount of public good already available Expect a hump shape: for t close to 0 we have z close to 0: raising t is desirable for t close to 1 we may have satiation in z: lowering t is desirable Eu a underprovision z < z* a overprovision z > z* a 18 t

19 Preferences for public and private goods How is z* determined? Optimal provision uses standard ΣMRS = MRT rule Because of the risk component general formula is unwieldy So take a simplified set of preferences u a (c, z) = c + v a (z) m a := u za (c, z)/u ca (c, z) = v za (z) m := Σm a = MRT Evasion erodes effectiveness of tax in providing z... feeds back into effect of tax on evasion change in (et) has sign of m y / z t a simple criterion for determining under / over provision c slope = m 19 z

20 Effect of a rise in the tax rate If the public goods are under-provided: a rise in t increases the amount of evasion over-provided: a rise in t decreases the amount of evasion Cowell and Gordon (1988) te But individuals differ in: risk aversion taste for public goods income So, different responses: constrained by e y high marginal evaluation low marginal evaluation ty t Get a more complex relationship between t and evasion overall 20

21 Overview... Reporting models. Climate of evasion and social sanction Tax Evasion and Compliance Background TAG model Interaction models Evidence 21

22 Strategic interaction Based on a application of game theory Two players: tax authority and taxpayer Tax authority chooses whether or not to investigate Taxpayer chooses whether or not to cheat Intuition of simple strategic model: simultaneous move if tax authority plays audit best response of taxpayer is report if taxpayer plays report best response of tax authority is not audit etc, etc. no equilibrium in pure strategies Intuition of simple strategic model: leader-follower if tax authority moves first, perhaps get a simple outcome Develop this into a richer policy model? focus on tax-collector/tax-payer interaction what role is there for beliefs about others goals and actions? can tax authority precommit to an audit strategy? 22

23 Social interaction Different countries, different types of compliance behaviour? develop a model of a compliance climate? (Cummings, et al. 2009) others evasion choices affect my evasion decision (Fortin et al. 2007) several possible foundations 1 Symmetric consumption externality if you evade maybe I feel less pain if caught behaving antisocially social stigma (Benjamini and Maital 1985, Kim 2003) 2 Technological (production) externality the more others evade the easier to find a corrupt accountant leads to reduction in noncompliance costs 3 May also be induced by tax authority auditing rules may induce a perceived interdependence creates a co-ordination game Alm and Mckee (2004) Develop the first of these variants. 23

24 Climate: model Evasion decisions affect outcomes in two ways each person s outcome affected by own choices (as before) also affected by evasion of others (independently of public goods) Nature of the consumption externality aggregate evasion affects utility moral climate? Utility of an a-type is V a (e,e) where e: Own evasion activity E: aggregate evasion In principle there are two subcases: 1 where aggregate E increases utility 2 where aggregate E reduces utility Focus on case 2 24

25 Interaction: model behaviour utility 0 V a (0,E) E * V a (y,e) aggregate evasion Y E The Evasion-Utility Space Payoffs if act honestly Payoffs if act dishonestly Check incentive to switch Dominant behaviour Find equilibrium Check stability min E = 0, max E = Y low E : individual switches to 0 high E: individual switches to y E > E * : switching increases E E < E * : switching decreases E Three equilibria: E = 0 (stable) E = E * (unstable) E = Y (stable) 25

26 Overview... What do we know? What can we know? Tax Evasion and Compliance Background TAG model Interaction models Evidence 26

27 Empirical evidence Few governments/agencies publish data For survey see Andreoni et al (1998) Best data (TCMP) enable one to address only a restricted set of questions Focus is on false reports. Limited info on non-filers. Last full TCMP in 1988 recently (2005/6) updated in National Research Program Private data must be treated with caution Survey data obviously problematic Experimental data sometimes useful (Alm et al ) Indirect methods are often seriously flawed Focus on aggregate expenditure/income gaps or the demand for currency neglect measurement error and other sources of discrepancy Some micro-data studies are useful focus on relationship between expenditure and income for self-employed on regularly employed (Pissarides and Weber 1989) focus on charity giving and different types income (Feldman and Slemrod 2007) 27

28 Personal compliance Behaviour varies by income type and population group (TCMP) Personal taxpayers income-elasticity of underreporting: 0.3 Farm business income income-elasticity of underreporting: 0.65 Source of income rather than level which is a significant determinant of evasion. Married people evade more than single persons Effect of tax rates: Less compliance in audit classes with higher marginal tax rates? Corroborated by evidence on the reporting of capital gains Corroborated also by time series? Enforcement parameters work in expected direction (TCMP): weak relationship with probability of audit weak relationship with severity of penalties Detection is imperfect (TCMP): variation in detection rates at least as important as variations in personal characteristics Slemrod et al (2001) controlled experiment results: as expected for modest incomes and for those with high opportunity to evade But high-income people reported less than those in control group 28

29 Compliance by firms Surveys: Nur-tegin (2008), Slemrod (2004) Evidence: Rice (1994) based on TCMP Highlights lack of... theoretical models corporate income tax compliance microdata; confidence in microdata on tax compliance Two key results: compliance positively associated with being publicly traded and belonging to a highly regulated industry having low profits relative to the industry median is correlated with higher corporate tax evasion 29

30 Evidence: summary TCMP evidence is broadly in line with evidence of responses from TAG model Confirmation as to evasion patterns by different groups according to income and personal characteristics However implied detection probability suggests that there is far too little tax evasion going on! may neglect heterogeneity of effective detection probability also taxpayer ignorance Responses are also borne out by experimental evidence (Alm et al.1990 ) 30

31 References (1) Allingham, M. and A. Sandmo (1972) Income tax evasion: a theoretical analysis, Journal of Public Economics, 1, Alm, J. and Mckee, M. (2004) Tax compliance as a coordination game, Journal of Economic Behavior & Organization 54, Alm, J., Bahl, R. and Murray, M. N. (1990) Understanding Taxpaying Behavior: A Conceptual Framework with Implications for Research, The Review of Economics and Statistics, 72, * Andreoni, J. Erard, B. and Feinstein, J. (1998) Tax Compliance, Journal of Economic Literature, 36, Benjamini, Y. and Maital, S. (1985) Optimal tax evasion and optimal tax evasion policy: behavioral aspects, in Gaertner, W. and Wenig, A. (eds) The Economics of the Shadow Economy, Springer Verlag, Berlin Cowell, F. A. (1990) Cheating the Government, MIT Press, Cambridge MA Cowell, F. A. (2004) Carrots and Sticks in Enforcement in Aaron, H. J. and Slemrod, J. (ed.) The Crisis in Tax Administration, The Brookings Institution, Washington DC, Cowell, F. A. and Gordon, J. P. F. (1988) Unwillingness to pay: tax evasion and public good provision, Journal of Public Economics, 36, Cummings, R. G., Martinez-Vazquez, J., McKee, M. and Torgler, B. (2009) Tax morale affects tax compliance: Evidence from surveys and an artefactual field experiment, Journal of Economic Behavior and Organization, 70, Feldman, N. E. and Slemrod, J. (2007) Estimating tax noncompliance with evidence from unaudited tax returns, The Economic Journal, 117, Fortin, B., Lacroix, G. and Villeval, M.-C. (2007) Tax evasion and social interactions, Journal of Public Economics, 91, HM Revenue and Customs (2011) Measuring Tax Gaps 2011 Kim, Y. (2003) Income distribution and equilibrium multiplicity in a stigma-based model of tax evasion, Journal of Public Economics,

32 References (2) McManus, J. and Warren, N. (2006) The Case for Measuring Tax Gap, ejournal of Tax Research, 4, Nur-tegin, K. D. (2008) Determinants of Business Tax Compliance, The B.E. Journal of Economic Analysis & Policy, 8, Article 18 Pissarides, C. and Weber, G. (1989) An Expenditure-Based Estimate of Britain's Black Economy, Journal of Public Economics, 39, Rice, E. M. (1994), The corporate tax gap: evidence on tax compliance by small corporations, in Slemrod, J. (ed.) Why people pay taxes, University of Michigan Press, p Slemrod, J. (2004) The Economics of Corporate Tax Selfishness, National Tax Journal, 57, Slemrod, J. (2007) Cheating Ourselves: The Economics of Tax Evasion, Journal of Economic Perspectives, 21, Slemrod, J., Blumenthal, M. and Christian, C. (2001) Taxpayer Response to an Increased Probability of Audit: Evidence from a Controlled Experiment in Minnesota, Journal of Public Economics, 79, Slemrod, J. and Yitzhaki, S. (2002) Tax avoidance, evasion and administration, Handbook of Public Economics, Volume 3, pp , North-Holland, Elsevier * Schneider, F. and Enste, D.H. (2000) Shadow economies: size, causes and consequences Journal of Economic Literature, 38, US Department of the Treasury, Internal Revenue Service (2006) Updated Estimates of the TY 2001 Individual Income Tax Underreporting Gap. Overview. February 22. Washington, D.C.: Office of Research, Analysis, and Statistics. 32