Appendix: Estimating Tax Evasion
In recent years, many scholars and governments have attempted to measure the size of tax evasion in particular countries, either for specific taxes or for the whole tax system. The measurement of tax evasion is obviously fraught with difficulties. Many of these difficulties have to do with the fact that the information available is, by its very nature, limited and often unreliable. However, there is a more philosophical difficulty often not acknowledged—namely, the problem that the statutory tax system that exists in a country that has a lot of tax evasion has been “contaminated” or influenced by the existence of the tax evasion. In other words, it is not the system that would exist in the absence of tax evasion: statutory rates have often been increased to compensate for the revenue losses associated with tax evasion. 21/ But if this is true, then when one uses the current statutory rates to measure tax evasion, one exaggerates the size of the evasion, since the rates would have been lower if the evasion had not been there.
Various methods have been used to measure tax evasion. Some of these try to measure it directly, some indirectly. Among the direct methods one can identify: (1) the use of the national accounts; (2) the use of direct controls; (3) the use of household budget surveys; and (4) direct surveys of taxpayer behavior. The indirect methods are largely related to estimates of the underground economy. Once the size of the underground economy has been measured, the extent to which the existence of the underground economy has implied tax revenue losses to the government must be assessed. In other words, undeclared income or some other unreported tax base must first be measured. Subsequently, an estimation of the unpaid tax must be made.
Aguirre, C.A., and P. Shome, “The Mexican Value-Added Tax: Methodology for Calculating the Base,” National Tax Journal, Vol. XLI, No. 4 (December 1988), pp. 543–54.
Allingham, M.G., and A. Sandmo, “Income Tax Evasion: A Theoretical Analysis,” Journal of Public Economics, Vol. 1, No. 3/4 (November 1972), pp. 323–38.
Ballard, C.L., J.B. Shoven, and J. Whalley, “The Total Welfare Cost of the United States Tax System: A General Equilibrium Approach,” National Tax Journal (June 1985), pp. 125–40.
Ballard, C.L., “General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States,” American Economic Review (March 1985), pp. 128–38.
Banerji, A., “Tax Evasion, Enforcement, and Intertemporal Choice,” Proceedings, 1991 National Tax Association Conference, Williamsburg (1991), pp. 90–100.
Bird, Richard, and Milka Casanegra de Jantscher, editors, Improving Tax Administration in Developing Countries, (Washington: International Monetary Fund, 1992).
Cremer, Helmuth, and Firouz Gahvari, “Tax Evasion and Optimal Commodity Taxation,” Journal of Public Economics, 50 (1993), pp. 261–75.
Internal Revenue Service, Estimates of Income Unreported on Individual Income Tax Returns (Washington, D.C.: Government Printing Office, September 1979).
Mackenzie, G.A., “Estimating the Base of the Value-Added Tax (VAT) in Developing Countries: The Problem of Exemptions,” Public Finance (forthcoming, 1993).
Richupan, S., “Determinants of Income Tax Evasion: Role of Tax Rates, Shape of Tax Schedule, and Other Factors,” in SupplySide Tax Policy: Its Relevance to Developing Countries, ed. by V.P. Gandhi (Washington, D.C.: International Monetary Fund, 1987).
Sandford, C.T., M. Godwin, and P. Hardwick, Administrative and Compliance Costs of Taxation (Bath, England: Fiscal Publishers, 1989).
Serra, Pablo, “Estimación de la Evasión Tributaria en el Impuesto al Valor Agregado,” Servicio de Impuestos Internos, Publicación No. 91/05/C, Universidad de Chile, Agosto 1991.
Sisson, C.A., “Tax Evasion: A Survey of Major Determinants and Policy Instruments of Control,” IMF Departmental Memorandum, DM/81/95 (1981).
Tanzi, V., The Individual Income Tax and Economic Growth (Baltimore: The Johns Hopkins University Press, 1969). A Japanese edition is also available.
Tanzi, V., “The Underground Economy in the United States: Estimates and Implications,” Banca Nazionale del Lavoro, Quarterly Review, No. 135 (December 1980), pp. 427–53.
Tanzi, V., “The Underground Economy in the United States: Annual Estimates, 1930-80,” Staff Papers, International Monetary Fund (Washington), Vol. 30 (June 1983), pp. 283–305.
Uchitelle, E., “The Effectiveness of Tax Amnesty Programs in Selected Countries,” Quarterly Review, Federal Reserve Bank of New York, Vol. 14, No. 3 (1989), pp. 48–53.
U.S. Department of the Treasury, Internal Revenue Service, Report on the Application and Administration of Section 482, Washington, D.C., April 1992.
Webley, P., H. Robben, H. Elffers, and D. Hessing, Tax Evasion: An Experimental Approach (Cambridge: Cambridge University Press, 1991).
The opinions expressed in the paper are those of the authors and not necessarily those of the International Monetary fund.
The tax gap is the measure of tax evasion that emerges from comparing taxable income declared to tax authorities with taxable income calculated from other and presumably more accurate sources.
Scholars have often made a distinction between tax evasion and tax avoidance. In theory tax evasion implies violation of the law whereas tax avoidance implies the taking advantage of ambiguities in the law to reduce the tax burden. This distinction, however, is not always easy and in fact in some countries, such as India, the courts have considered tax avoidance with the intention of evading taxation as tax evasion.
Several requests by Latin American countries for IMF technical assistance have had the objective of measuring tax evasion.
In recent years new developments in industrial organization and in technology have introduced totally new ways of evading taxes, for example, through transfer pricing and thin capitalization.
During the electoral campaign, President Clinton argued that the reduction of tax evasion by multinationals could generate a lot of revenue. Recent work by the U.S. Internal Revenue Service has given some support to this view (see U.S. Treasury (1992)).
There is actually a close relationship between Allingham and Sandmo’s theory of tax evasion and Becker’s theory of crime (1968).
Becker’s theory assumes that individuals evaluate the expected benefits and costs of various activities including criminal activities and choose those that provide the highest income.
The theory assumes a close relationship between increasing costs of administration and increasing the probability of catching tax evaders. The importance of this assumption has to be kept in mind.
In some cases they may be so delayed in time that they lose their deterrence effect.
Sometimes the taxpayers benefit from the delay due to the low interest rates charged on the taxes that were due. Some countries require an advance payment of the tax assessed after the tax evasion is discovered even when the taxpayer contests the assessment.
However, appeals are not costless in terms of time, worries, and lawyers’ and other fees.
For a recent important contribution to the literature on tax administration, see Bird and Casanegra (1992).
This literature concludes that in the presence of tax evasion some of the standard conclusions of optimal taxation do not hold.
Thus, the compliance cost per dollar paid can be defined as the excess cost to the taxpayer in terms of lost time, payments to lawyers and accountants, etc. of $1 of tax payment.
Anecdotal reports have referred to countries where some key posts in the tax administration have been in high demand by those who took civil service exams or have even been “sold” to the highest bidders. Obviously these posts provided possibilities of high “incomes.”
Italy has been, perhaps, the most imaginative in the use of presumptive taxes in recent years.
In fact, the theoretically advocated and practically followed procedure of selecting taxpayers through audits to detect tax evaders raises serious questions of equity when many other tax evaders remain undetected and unpunished.
This point was clearly recognized by Luigi Einaudi, the prominent public finance scholar who became President of Italy. Once he remarked that if all the Italian tax laws on the books were fully enforced, the Italian level of taxation would be 120 percent of national income.
The reverse is also true for capital gains which may be in the concept of taxable income but are not in the national accounts.
In the expenditure side method, exports are already excluded from the domestic expenditure base.
See Internal Revenue Service (1979). This method is different from that outlined for estimating evasion by wage earners in the previous section. The sampling method that is being described here is based on a sample selected for special scrutiny on a continuing basis, and is used in lieu of the national accounts method.
See paper on Norway, by Isachsen, Klovland, and Strom, and paper on Sweden by Hansson in Tanzi (1982).