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Vito Tanzi is Director of the Fiscal Affairs Department. He holds a doctorate from Harvard University. Parthasarathi Shome is Chief, Tax Policy Division. He holds a doctorate from Southern Methodist University. The opinions expressed in the paper are those of the authors and are not necessarily those of the International Monetary Fund.
The tax gap emerges from comparing taxable income declared to tax authorities with taxable income calculated from other, presumably more accurate, sources.
Scholars often make a distinction between tax evasion and tax avoidance. In theory, tax evasion implies violation of the law whereas tax avoidance implies taking advantage of ambiguities in the law to reduce the tax burden. This distinction, however, is not always easy and in some countries, such as India, the courts have considered tax avoidance with the intention of evading taxation as tax evasion.
Several Latin American countries have requested IMF technical assistance for measuring tax evasion.
In recent years, new developments in industrial organization and in technology have introduced new ways of evading taxes.
During the electoral campaign, now-President Bill Clinton argued that the reduction of tax evasion by multinationals could generate a good deal 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 (1968) theory of crime.
Becker’s (1968) theory assumes that individuals evaluate the expected benefits and costs of various activities, including criminal activities, and choose those that provide the highest income, taking account of the associated net costs.
The theory assumes a close positive relationship between the costs of administration and the probability of catching tax evaders. The importance of this assumption should be kept in mind.
In some cases, penalties may be so delayed that they lose their deterrence effect.
Sometimes the taxpayer benefits from the delay owing to the low interest rates charged on the taxes that were due. Some countries require an advance payment of the assessed tax even when the taxpayer contests the assessment.
However, appeals are not costless in terms of time, worry, and legal or other fees.
But, see Goode (1981).
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 regarding 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, and so forth of $1 of tax payment.
In some cases, they have to spend considerable time just getting the right forms.
Anecdotal reports have referred to countries where some key posts in the tax administration have been in high demand or even“sold” to the highest bidders. Obviously these posts provide possibilities of high“incomes.”
Italy has perhaps been the most imaginative in the use of presumptive taxes in recent years.
In fact, the theoretically advocated and practically followed procedure of detecting tax evasion through selected audits 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. He once 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 not in the national accounts.
In the expenditure side method, exports are already excluded from the domestic expenditure base.
For a discussion of this point, see the paper by Reuter in Tanzi (1982).
See Internal Revenue Service (1979). This method is different from that outlined 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 the paper on Norway by Isachsen, Klovland, and Strom, and the paper on Sweden by Hansson in Tanzi (1982).
These methods are discussed in Tanzi (1982).
Tanzi (1980, 1983) used this method to estimate first the size of the underground economy in the United States and then tax evasion.