High-Income Tax Avoidance Far Larger Than Thought, New Paper Estimates
The very top sliver of high-income Americans may underreport their income at levels far beyond what was suggested by prior IRS research, according to a new paper
Citing the research, IRS Commissioner Charles Rettig contended that each additional dollar spent on tax enforcement could yield $5 to $7 in revenue.
PHOTO: SAMUEL CORUM/BLOOMBERG NEWS
WASHINGTON—The top sliver of high-income Americans dodge significantly more in income taxes than the Internal Revenue Service’s methods had previously assumed, according to forthcoming estimates from IRS researchers and academic economists.
Overall, the paper estimates that the top 1% of households fail to report about 21% of their income, with 6 percentage points of that due to sophisticated strategies that random audits don’t detect. For the top 0.1%, unreported income may be nearly twice as large as conventional IRS methodologies would suggest, the researchers wrote.
These strategies include offshore tax avoidance, which may have waned after stricter reporting requirements took effect about a decade ago. But many high-income Americans also use partnerships and similar entities to avoid taxes, and such behavior may be increasing and becoming harder for tax authorities to find and untangle, said Daniel Reck of the London School of Economics, the paper’s lead nongovernment author.
Such pass-through businesses—where income passes directly onto their owners’ individual tax returns and isn’t taxed at the corporate level—are a large and increasingly important part of the wealth of the top 1%, particularly the top 0.1%. Investment funds, real-estate businesses and closely held family firms across industries are often structured as partnerships. Partnerships themselves are, of course, legal to use, but the IRS has struggled to find tax dodging inside webs of connected entities.
“There is more revenue than you might have thought at the very top,” Mr. Reck said. “What’s needed is a broader strategy that involves increased scrutiny of pass-through businesses [and] investments in the comprehensive audits that the IRS does in its global high-wealth program.”
IRS Commissioner Charles Rettig briefly referenced the research—slated for release Monday as a National Bureau of Economic Research working paper—in congressional testimony last week as he urged lawmakers to give the agency more money for enforcement.
“It is not just a body count of how many people we have in enforcement,” Mr. Rettig said, contending that each additional dollar spent on tax enforcement could yield $5 to $7 in revenue. “We need to have specialized agents.”
Research on tax avoidance and evasion can be difficult and imprecise because it requires seeing what has been intentionally hidden. Some of the behavior in question would be categorized as clear criminal tax evasion, while some would fall in the grayer areas of noncompliance. The paper emphasizes that more work is needed to measure tax compliance by high-income Americans. The authors include John Guyton and Patrick Langetieg of the IRS, Max Risch of Carnegie Mellon University and Gabriel Zucman, a University of California, Berkeley economist who has advocated an annual wealth tax.
IRS audit rates and enforcement staffing have declined steadily for a decade amid budget cuts, some from across-the-government reductions and some focused on the IRS after the agency said it had given some conservative groups improper scrutiny. President Biden and other Democrats have proposed reversing that trend with a significant expansion of the U.S. tax agency.
The most ambitious proposals include estimates that a beefed-up IRS, armed with more people and tougher rules requiring more reporting of financial information by businesses, could collect an additional $1 trillion over a decade without raising taxes. Some Republicans have shown recent openness to expanding the IRS budget, but Democrats have yet to try advancing the far-reaching proposals.
Using internal IRS tax-return data, the researchers looked at people who disclosed offshore accounts about a decade ago when the IRS was encouraging people to come forward in exchange for more-lenient treatment. They found that hundreds of them had been picked years before their disclosures for the random audits that the IRS uses to measure tax avoidance—and that the IRS auditors found the offshore accounts just 7% of the time.
For the pass-through businesses and complex partnerships, the researchers assumed noncompliance rates between those of large corporations and sole proprietorships, both areas where the IRS has better data than in those random audits it uses for research purposes on pass-throughs. That led to higher projections of avoidance than previous IRS methods.
The research is an important contribution to the understanding of tax avoidance and should bolster calls to give the IRS more resources, said Jason DeBacker, a professor at the University of South Carolina who has written separately on the subject.
However, he said some of the result hinges on assumptions about pass-through businesses that are reasonable but less concrete than the way other avoidance is measured.
“They don’t have as clean of an approach for identifying what the [IRS] misses from pass-through income as they do for offshore income,” Mr. DeBacker said in an email.
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