Tax avoidance

From Wikipedia, the free encyclopedia

Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. Tax sheltering is very similar, although unlike tax avoidance tax sheltering is not necessarily legal. Tax havens are jurisdictions which facilitate reduced taxes.

While forms of tax avoidance which use tax laws in ways not intended by governments may be considered legal, it is almost never considered moral in the court of public opinion and rarely in journalism. Many corporations and businesses which take part in the practice experience a backlash, either from their active customers or online. Conversely, benefiting from tax laws in ways which were intended by governments is sometimes referred to as "tax planning". The World Bank's World Development Report 2019 on the future of work supports increased government efforts to curb tax avoidance as part of a new social contract focused on human capital investments and expanded social protection.

Tax mitigation, "tax aggressive", "aggressive tax avoidance" or "tax neutral" schemes generally refer to multi-territory schemes that fall into the grey area between commonplace and well-accepted tax avoidance (such as purchasing municipal bonds in the United States) and evasion, but are widely viewed as unethical, especially if they are involved in profit-shifting from high-tax to low-tax territories and territories recognised as tax havens. Since 1995, trillions of dollars have been transferred from OECD and developing countries into tax havens using these schemes.

Laws known as a General Anti-Avoidance Rule (GAAR) statutes which prohibit "tax aggressive" avoidance have been passed in several countries and regions including Canada, Australia, New Zealand, South Africa, Norway, Hong Kong and the United Kingdom. In addition, judicial doctrines have accomplished the similar purpose, notably in the United States through the "business purpose" and "economic substance" doctrines established in Gregory v. Helvering and in the UK through the Ramsay case. Though the specifics may vary according to jurisdiction, these rules invalidate tax avoidance which is technically legal but not for a business purpose or in violation of the spirit of the tax code. Related terms for tax avoidance include tax planning and tax sheltering.

The term avoidance has also been used in the tax regulations of some jurisdictions to distinguish tax avoidance foreseen by the legislators from tax avoidance which exploits loopholes in the law such as like-kind exchanges. The United States Supreme Court has stated that "The legal right of an individual to decrease the amount of what would otherwise be his taxes or altogether avoid them, by means which the law permits, cannot be doubted."

Tax evasion, on the other hand, is the general term for efforts by individuals, corporations, trusts and other entities to evade taxes by illegal means. Both tax evasion and some forms of tax avoidance can be viewed as forms of tax noncompliance, as they describe a range of activities that are unfavorable to a state's tax system.

Anti-avoidance measures

An anti-avoidance measure is a rule that prevents the reduction of tax by legal arrangements, where those arrangements are put in place purely to reduce tax, and would not otherwise be regarded as a reasonable course of action.

Methods

Country of residence

A company may choose to avoid taxes by establishing their company or subsidiaries in an offshore jurisdiction (see offshore company and offshore trust). Individuals may also avoid tax by moving their tax residence to a tax haven, such as Monaco, or by becoming a perpetual traveler. They may also reduce their tax by moving to a country with lower tax rates.

However, a small number of countries tax their citizens on their worldwide income regardless of where they reside. As of 2012, only the United States and Eritrea have such a practice, whilst Finland, France, Hungary, Italy and Spain apply it in limited circumstances. In cases such as the US, taxation cannot be avoided by simply transferring assets or moving abroad.

The United States is unlike almost all other countries in that its citizens and permanent residents are subject to U.S. federal income tax on their worldwide income even if they reside temporarily or permanently outside the United States. U.S. citizens therefore cannot avoid U.S. taxes simply by emigrating from the U.S. According to Forbes magazine some citizens choose to give up their United States citizenship rather than be subject to the U.S. tax system; but U.S. citizens who reside (or spend long periods of time) outside the U.S. may be able to exclude some salaried income earned overseas (but not other types of income unless specified in a bilateral tax treaty) from income in computing the U.S. federal income tax. The 2015 limit on the amount that can be excluded is US$100,800. In addition, taxpayers can exclude or deduct certain foreign housing amounts. They may also be entitled to exclude from income the value of meals and lodging provided by their employer. Some American parents don’t register their children’s birth abroad with American authorities, because they do not want their children to be required to report all earnings to the IRS and pay American taxes for their entire lives, even if they never visit the United States.

Double taxation

Most countries impose taxes on income earned or gains realized within that country regardless of the country of residence of the person or firm. Most countries have entered into bilateral double taxation treaties with many other countries to avoid taxing nonresidents twice—once where the income is earned and again in the country of residence (and perhaps, for U.S. citizens, taxed yet again in the country of citizenship)—however, there are relatively few double-taxation treaties with countries regarded as tax havens. To avoid tax, it is usually not enough to simply move one's assets to a tax haven. One must also personally move to a tax haven (and, for U.S. citizens, renounce one's citizenship) to avoid tax.

Legal entities

Without changing country of residence (or, if a U.S. citizen, without giving up one's citizenship), personal taxation may be legally avoided by the creation of a separate legal entity to which one's property is donated. The separate legal entity is often a company, trust, or foundation. These may also be located offshore, such as in the case of many private foundations. Assets are transferred to the new company or trust so that gains may be realized, or income earned, within this legal entity rather than earned by the original owner. If assets are later transferred back to an individual, then capital gains taxes would apply on all profits. Also income tax would still be due on any salary or dividend drawn from the legal entity. 

For a settlor (creator of a trust) to avoid tax there may be restrictions on the type, purpose and beneficiaries of the trust. For example, the settlor of the trust may not be allowed to be a trustee or even a beneficiary and may thus lose control of the assets transferred and/or may be unable to benefit from them.

Legal vagueness

Tax results depend on definitions of legal terms which are usually vague. For example, vagueness of the distinction between "business expenses" and "personal expenses" is of much concern for taxpayers and tax authorities. More generally, any term of tax law has a vague penumbra, and is a potential source of tax avoidance.

Tax shelters

Tax shelters are investments that allow, and purport to allow, a reduction in one's income tax liability. Although things such as home ownership, pension plans, and Individual Retirement Accounts (IRAs) can be broadly considered "tax shelters", insofar as funds in them are not taxed, provided that they are held within the Individual Retirement Account for the required amount of time, the term "tax shelter" was originally used to describe primarily certain investments made in the form of limited partnerships, some of which were deemed by the U.S. Internal Revenue Service to be abusive.

The Internal Revenue Service and the United States Department of Justice have recently teamed up to crack down on abusive tax shelters. In 2003 the Senate's Permanent Subcommittee on Investigations held hearings about tax shelters which are entitled U.S. tax shelter industry: the role of accountants, lawyers, and financial professionals. Many of these tax shelters were designed and provided by accountants at the large American accounting firms.

Examples of U.S. tax shelters include: Foreign Leveraged Investment Program (FLIP) and Offshore Portfolio Investment Strategy (OPIS). Both were devised by partners at the accounting firm, KPMG. These tax shelters were also known as "basis shifts" or "defective redemptions." 

Prior to 1987, passive investors in certain limited partnerships (such as oil exploration or real estate investment ventures) were allowed to use the passive losses (if any) of the partnership (i.e., losses generated by partnership operations in which the investor took no material active part) to offset the investors' income, lowering the amount of income tax that otherwise would be owed by the investor. These partnerships could be structured so that an investor in a high tax bracket could obtain a net economic benefit from partnership-generated passive losses.

In the Tax Reform Act of 1986 the U.S. Congress introduced the limitation (under 26 U.S.C. § 469) on the deduction of passive losses and the use of passive activity tax credits. The 1986 Act also changed the "at risk" loss rules of 26 U.S.C. § 465. Coupled with the hobby loss rules (26 U.S.C. § 183), the changes greatly reduced tax avoidance by taxpayers engaged in activities only to generate deductible losses.

Transfer mispricing

Fraudulent transfer pricing, sometimes called transfer mispricing, also known as transfer pricing manipulation, refers to trade between related parties at prices meant to manipulate markets or to deceive tax authorities. 

For example, if company A, a food grower in Africa, processes its produce through three subsidiaries: X (in Africa), Y (in a tax haven, usually offshore financial centers) and Z (in the United States). Now, Company X sells its product to Company Y at an artificially low price, resulting in a low profit and a low tax for Company X based in Africa. Company Y then sells the product to Company Z at an artificially high price, almost as high as the retail price at which Company Z would sell the final product in the U.S.. Company Z, as a result, would report a low profit and, therefore, a low tax. About 60% of capital flight from Africa is from improper transfer pricing. Such capital flight from the developing world is estimated at ten times the size of aid it receives and twice the debt service it pays.

The African Union reports estimates that about 30% of Sub-Saharan Africa's GDP has been moved to tax havens. Solutions include corporate “country-by-country reporting” where corporations disclose activities in each country and thereby prohibit the use of tax havens where real economic activity occurs.

Tax avoiders

United Kingdom

HMRC, the UK tax collection agency, estimated that the overall cost of tax avoidance in the UK in 2016-17 was £1.7 billion, of which £0.7 billion was loss of income tax, National Insurance contributions and Capital Gains Tax. The rest came from loss of Corporation Tax, VAT and other direct taxes. This compares to the wider tax gap (the difference between the amount of tax that should, in theory, be collected by HMRC, against what is actually collected) in that year of £33 billion.

Figures published by the Tax Justice Network show that the UK had one of the lowest rates of tax losses due to profit shifting by multinational companies, with the fourth lowest rate out of 102 countries studied. According to the figures, the UK lost £1 billion from profit shifting, around 0.04% of its GDP, coming behind Botswana (0.02%), Ecuador (0.02%) and Sweden (0.004%).

Large companies accused of tax avoidance

In 2008 it was reported by Private Eye that Tesco utilized offshore holding companies in Luxembourg and partnership agreements to reduce corporation tax liability by up to £50 million a year. Another scheme previously identified by Private Eye involved depositing £1 billion in a Swiss partnership, and then loaning out that money to overseas Tesco stores, so that profit can be transferred indirectly through interest payments. This scheme is reported to remain in operation and is estimated to be costing the UK exchequer up to £20 million a year in corporation tax.

In 2011, ActionAid reported that 25% of the FTSE 100 companies avoided taxation by locating their subsidiaries in tax havens. This increased to 98% when using the stricter US Congress definition of tax haven and bank secrecy jurisdictions. In 2016, it was reported in the Private Eye current affairs magazine that four out of the FTSE top 10 companies paid no corporation tax at all.

Tax avoidance by corporations came to national attention in 2012, when MPs singled out Google, Amazon.com and Starbucks for criticism. Following accusations that the three companies were diverting hundreds of millions of pounds in UK profits to secretive tax havens, there was widespread outrage across the UK, followed by boycotts of products by Google, Amazon.com and Starbucks. Following the boycotts and damage to brand image, Starbucks promised to move its tax base from the Netherlands to London and to pay HMRC £20million, but executives from Amazon.com and Google defended their tax avoidance as being within the law. 

Google has remained the subject of criticism in the UK regarding their use of the 'Double Irish', Dutch Sandwich and Bermuda Black Hole tax avoidance schemes. Similarly, Amazon remains the subject of criticism across the UK and EU for its tax avoidance, with a 'sweetheart deal' between Luxembourg and Amazon.com enabling the American company to pay little to no corporate tax across Europe declared illegal in 2015. PayPal, EBay, Microsoft, Twitter and Facebook have also been found to be using the Double Irish and Dutch Sandwich schemes. Up to 1,000 individuals in the same year were also discovered to be using K2 to avoid tax.

Other UK active corporations mentioned in relation to tax avoidance in 2015, particularly the Double Irish, Dutch Sandwich and Bermuda Black Hole:

• Technology: Apple, Microsoft, PayPal, EBay, Intel, Yahoo!, Facebook, Uber, Netflix, Hewlett-Packard, IBM, and Twitter
• Retail: Boots (who moved their registered office to a Swiss letterbox), Kellogg's, and TopShop
• Football clubs: Manchester United, Birmingham City, Coventry City and Cheltenham Town.
• News: Daily Mail

Other corporations mentioned in relation to tax avoidance in later years have been Vodafone, AstraZeneca, SABMiller, GlaxoSmithKline and British American Tobacco.

Tax avoidance has not always related to corporation tax. A number of companies including Tesco, Sainsburys, WH Smith, Boots and Marks and Spencer used a scheme to avoid VAT by forcing customers paying by card to unknowingly pay a 2.5% 'card transaction fee', though the total charged to the customer remained the same. Such schemes came to light after HMRC litigated against Debenhams over the scheme during 2005.

General anti-avoidance rule

Since the late 1990s, New Labour consulted on a "general anti-avoidance rule" (GAAR) for taxation, before deciding against the idea. By 2003, public interest in a GAAR surged as evidence of the scale of tax avoidance used by individuals in the financial and other sectors became apparent, though in its 2004 Budget the Labour Government announced a new "disclosure regime" as an alternative, whereby tax avoidance schemes would be required to be disclosed to the revenue departments.

In December 2010, the new Coalition government commissioned a report which would consider whether there should be a general anti-avoidance rule for the UK, which recommended that the UK should introduce such a rule, which was introduced in 2013. The rule prevents the reduction of tax by legal arrangements, where those arrangements are put in place purely to reduce tax, and would not otherwise be regarded as a reasonable course of action.

Following the Panama Papers leak, Private Eye, The Guardian and other British media outlets noted that Edward Troup, who became executive chair of HM Revenue and Customs, worked with Simmons & Simmons in 2004 representing corporate tax havens and opposed the GAAR in 1998.

Historical tax avoidance

Window tax

Avoiding the window tax in England

 

One historic example of tax avoidance still evident today was the payment of window tax. It was introduced in England and Wales in 1696 with the aim of imposing tax on the relative prosperity of individuals without the controversy of introducing an income tax. The bigger the house, the more windows it was likely to have, and the more tax the occupants would pay. Nevertheless, the tax was unpopular, because it was seen by some as a "tax on light" (leading to the phrase daylight robbery) and led property owners to block up windows to avoid it. The tax was repealed in 1851.

Deliberate roof destruction

Other historic examples of tax avoidance were the deliberate destructions of roofs in Scotland to avoid substantial property taxes. The roof of Slains Castle was removed in 1925, and the building has deteriorated since. The owners Fetteresso Castle (now restored) deliberately destroyed their roof after World War II in protest at the new taxes.

United States

An IRS report indicates that, in 2009, 1,470 individuals earning more than $1,000,000 annually faced a net tax liability of zero or less. Also, in 1998 alone, a total of 94 corporations faced a net liability of less than half the full 35% corporate tax rate and the corporations Lyondell Chemical, Texaco, Chevron, CSX, Tosco, PepsiCo, Owens & Minor, Pfizer, JP Morgan, Saks, Goodyear, Ryder, Enron, Colgate-Palmolive, Worldcom, Eaton, Weyerhaeuser, General Motors, El Paso Energy, Westpoint Stevens, MedPartners, Phillips Petroleum, McKesson and Northrup Grumman all had net negative tax liabilities. Additionally, this phenomenon was widely documented regarding General Electric in early 2011.

Furthermore, a Government Accountability Office study found that, from 1998 to 2005, 55 percent of United States companies paid no federal income taxes during at least one year in a seven-year period it studied. A review in 2011 by Citizens for Tax Justice and the Institute on Taxation and Economic Policy of companies in the Fortune 500 profitable every year from 2008 through 2010 stated these companies paid an average tax rate of 18.5% and that 30 of these companies actually had a negative income tax due.

In 2012, Hewlett-Packard lost a lawsuit with the IRS over a "foreign tax credit generator" which was engineered by a division of AIG. Al Jazeera also wrote in 2012 that "Rich individuals and their families have as much as $32 trillion of hidden financial assets in offshore tax havens, representing up to $280bn in lost income tax revenues ... John Christensen of the Tax Justice Network told Al Jazeera that he was shocked by 'the sheer scale of the figures'. ... 'We're talking about very big, well-known brands – HSBC, Citigroup, Bank of America, UBS, Credit Suisse ... and they do it knowing fully well that their clients, more often than not, are evading and avoiding taxes.' Much of this activity, Christensen added, was illegal."

As a result of the tax sheltering, the government responded with Treasury in Treasury Department Circular 230. In 2010, the Health Care and Education Reconciliation Act of 2010 codified the "economic substance" rule of Gregory v. Helvering (1935).

The US Public Interest Research Group said in 2014 that the United States loses roughly $184 billion per year due to corporations such as Pfizer, Microsoft and Citigroup using offshore tax havens to avoid paying US taxes. According to PIRG:

• Pfizer paid no US income taxes 2010–2012, despite earning $43 billion. The corporation received more than $2 billion in federal tax refunds. In 2013, Pfizer operated 128 subsidiaries in tax havens and had $69 billion offshore which could not be collected by the Internal Revenue Service (IRS);
• Microsoft maintains five tax haven subsidiaries and held $76.4 billion overseas in 2013, thus saving the corporation $24.4 billion in taxes;
• Citigroup maintained 21 subsidiaries in tax haven countries in 2013, and kept $43.8 billion in offshore jurisdictions, thus saving the corporation an additional $11.7 billion in taxes.

Public opinion

Tax avoidance may be considered to be the dodging of one's duties to society, or alternatively the right of every citizen to structure one's affairs in a manner allowed by law, to pay no more tax than what is required. Attitudes vary from approval through neutrality to outright hostility. Attitudes may vary depending on the steps taken in the avoidance scheme, or the perceived unfairness of the tax being avoided.

In 2008, the charity Christian Aid published a report, Death and taxes: the true toll of tax dodging, which criticised tax exiles and tax avoidance by some of the world's largest companies, linking tax evasion to the deaths of millions of children in developing countries. However the research behind these calculations has been questioned in a 2009 paper prepared for the UK Department for International Development. According to the Financial Times there is a growing trend for charities to prioritise tax avoidance as a key campaigning issue, with policy makers across the world considering changes to make tax avoidance more difficult.

In 2010, tax avoidance became a hot-button issue in the UK. An organisation, UK Uncut, began to encourage people to protest at local high-street shops that were thought to be avoiding tax, such as Vodafone, Topshop and the Arcadia Group.

In 2012, during the Occupy movement in the United States, tax avoidance for the 99% was proposed as a protest tool.

Prem Sikka, Professor of Accounting at the Essex Business School (University of Essex) and scientific advisor of the Tax Justice Network pointed to a discrepancy between the Corporate Social Responsibility claims of multinational companies and “their internal dynamics aimed at maximising their profits through things like tax avoidance”. He wrote in an article commenting the Lux Leaks publications: “Big corporations and accountancy firms are engaged in organised hypocrisy.”

Fair Tax Mark

As a response to public opinion regarding tax avoidance, the Fair Tax Mark was established in the UK during 2014 as an independent certification scheme to identify companies which pay taxes "in accordance with the spirit of all tax laws" and not to use options, allowances, or reliefs, or undertake specific transactions, "that are contrary to the spirit of the law". The Mark is operated by a not-for-profit community benefit society. 

Awardees of this mark include The Co-op, SSE, Go-Ahead Group, Lush Cosmetics, Marshalls, several large regional co-operatives (East of England, Midcounties, Scotmid) and The Phone Co-op.

Government and judicial response

Countries with politicians, public officials or close associates implicated in the Panama Papers leak on April 15, 2016

 

Tax avoidance reduces government revenue, so governments with a stricter anti-avoidance stance seek to prevent tax avoidance or keep it within limits. The obvious way to do this is to frame tax rules so that there is a smaller scope for avoidance. In practice this has not always been achievable and has led to an ongoing battle between governments amending legislation and tax advisors finding new scope/loopholes for tax avoidance in the amended rules.

To allow prompter response to tax avoidance schemes, the US Tax Disclosure Regulations (2003) require prompter and fuller disclosure than previously required, a tactic which was applied in the UK in 2004. 

Some countries such as Canada, Australia, United Kingdom and New Zealand have introduced a statutory General Anti-Avoidance Rule (or General Anti-Abuse Rule, GAAR). Canada also uses Foreign Accrual Property Income rules to obviate certain types of tax avoidance. In the United Kingdom many provisions of the tax legislation (known as "anti-avoidance" provisions) apply to prevent tax avoidance where the main object (or purpose), or one of the main objects (or purposes), of a transaction is to enable tax advantages to be obtained. 

In the United States, the Internal Revenue Service distinguishes some schemes as "abusive" and therefore illegal. The Alternative Minimum Tax was developed to reduce the impact of certain tax avoidance schemes. Furthermore, while tax avoidance is in principle legal, if the IRS in its sole judgment determines that tax avoidance is the 'principal purpose' for an expatriation attempt, 'covered expat' status will be applied to the requester, thereby forcing an expatriation tax on worldwide assets to be paid as a condition of expatriation. The IRS presumes a principal purpose of tax avoidance if a taxpayer requesting expatriation has a net worth of $622,000 or more, or has had more than $124,000 in average annual net income tax over the 5 tax years ending before the date of expatriation.

United Kingdom

In the UK, judicial doctrines to prevent tax avoidance began in IRC v Ramsay (1981) which decided that where a transaction has pre-arranged artificial steps that serve no commercial purpose other than to save tax, the proper approach is to tax the effect of the transaction as a whole. This is known as the Ramsay principle and this case was followed by Furniss v. Dawson (1984) which extended the Ramsay principle. This approach has been rejected in most Commonwealth jurisdictions even in those where UK cases are generally regarded as persuasive. After two decades, there have been numerous decisions, with inconsistent approaches, and both the Revenue authorities and professional advisors remain quite unable to predict outcomes. For this reason this approach can be seen as a failure or at best only partly successful. 

In the judiciary, different judges have taken different attitudes. As a generalisation, for example, judges in the United Kingdom before the 1970s regarded tax avoidance with neutrality; but nowadays they may regard aggressive tax avoidance with increasing hostility.

In the UK in 2004, the Labour government announced that it would use retrospective legislation to counteract some tax avoidance schemes, and it has subsequently done so on a few occasions, notably BN66. Initiatives announced in 2010 suggest an increasing willingness on the part of HMRC to use retrospective action to counter avoidance schemes, even when no warning has been given.

The UK Government has pushed the initiative led by the Organisation for Economic Co-operation and Development (OECD) on base erosion and profit shifting. In the 2015 Autumn Statement, Chancellor George Osborne announced that £800m would be spent on tackling tax avoidance in order to recover £5 billion a year by 2019–20. In addition, large companies will now have to publish their UK tax strategies and any large businesses that persistently engage in aggressive tax planning will be subject to special measures. With these policies, Osborne has claimed to be at the forefront of combating tax avoidance. However, he has been criticised over his perceived inaction on enacting policies set forth by the OECD to combat tax avoidance.

In April 2015, the Chancellor George Osborne announced a tax on diverted profits, quickly nicknamed the "Google Tax" by the press, designed to discourage large companies moving profits out of the UK to avoid tax. In 2016, Google agreed to pay back £130m of tax dating back to 2005 to HMRC, which said it was the "full tax due in law". However, this amount of tax has been criticised by Labour, with Labour leader Jeremy Corbyn saying that the rate of tax paid by Google only amounted to 3%. Former Liberal Democrat Business Secretary Vince Cable also said Google had "got off very, very lightly", and Osborne "made a fool of himself" by hailing the deal as a victory. Although claiming that it was "absurd" to lay blame onto Google for tax avoidance, saying that EU member states should "[compete] with each other to offer firms the lowest corporate tax rates", Conservative MP Boris Johnson said it was a "good thing" for corporations to pay more tax. However, Johnson said he did not want tax rates to go up or for European Union countries to do this in unison.

Tax evasion in the United States

From Wikipedia, the free encyclopedia

 

Under the federal law of the United States of America, tax evasion or tax fraud, is the purposeful illegal attempt of a taxpayer to evade assessment or payment of a tax imposed by Federal law. Conviction of tax evasion may result in fines and imprisonment. Compared to other countries, Americans are more likely to pay their taxes fairly, honestly, and on time.

Tax evasion is separate from tax avoidance, which is the legal utilization of the tax regime to one's own advantage in order to reduce the amount of tax that is payable by means that are within the law. For example, a person can legally avoid some taxes by refusing to earn more taxable income, or by buying fewer things subject to sales taxes. Tax evasion is illegal, while tax avoidance is legal.

In Gregory v. Helvering the US Supreme Court concurred with Judge Learned Hand's statement that: "Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes." However, the court also ruled there was a duty not to illegally distort the tax code so as to evade paying one's legally required tax burden.

Definition

The tax code, 26 United States Code section 7201, provides:

Sec. 7201. Attempt to evade or defeat tax

Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.

To prove a violation of the statute, the prosecutor must show (1) the existence of a tax deficiency (an unpaid federal tax), (2) an affirmative act constituting an evasion or attempted evasion of either the assessment or payment of that tax, and (3) willfulness (connoting the voluntary, intentional violation of a known legal duty).

A genuine, good faith belief that one is not violating the Federal tax law based on a misunderstanding caused by the complexity of the tax law is a defense to a charge of "willfulness", even though that belief is irrational or unreasonable. A belief that the Federal income tax is invalid or unconstitutional is not a misunderstanding caused by the complexity of the tax law, and is not a defense to a charge of "willfulness", even if that belief is genuine and is held in good faith.

Occurrence

Nearly all Americans believe that cheating on taxes is morally and ethically unacceptable. The voluntary compliance rate (a technical measurement of taxes being paid both on time and voluntarily) in the US is generally around 81 to 84%. This is one of the highest rates in the world. By contrast, Germany's voluntary compliance rate is 68%, and Italy's is 62%.

The Internal Revenue Service (IRS) has identified small business and sole proprietorship employees as the largest contributors to the tax gap between what Americans owe in federal taxes and what the federal government receives. Small business and sole proprietorship employees contribute to the tax gap because there are few ways for the government to know about skimming or non-reporting of income without mounting more significant investigations.

The willful failures to report tips, income from side-jobs, other cash receipts, and barter income items are examples of illegal cheating. Similarly, those persons who are self-employed (or who run small businesses) evade the assessment or payment of taxes if they intentionally fail to report income. One study suggested that the fact that sharing economy firms like Airbnb, Lyft, and Etsy do not file 1099-K forms when participants earn less than $20,000 and have fewer than 200 transactions, results in significant unreported income. A recent survey found that the amount of unreported income for 2016 in the United States numbered at US $214.6 billion, with one in four Americans not reporting the money made on side-jobs.

The typical tax evader in the United States is a male under the age of 50 in the highest tax bracket and with a complicated return, and the most common means of tax evasion is overstatement of charitable contributions, particularly church donations.

Foreign tax havens

Jurisdictions which allow for limiting taxation, known as tax havens, may be used for both legally avoiding taxes and illegally evading taxes. In 2010, the Foreign Account Tax Compliance Act was passed to better enforce taxation in foreign jurisdictions.

Illegal income

U.S. citizens are required to report unlawful gains as income when filing annual tax returns (see e.g., James v. United States) although such income is typically not reported. Suspected lawbreakers, most famously Al Capone, have been successfully prosecuted for tax evasion when there was insufficient evidence to try them for their non-tax related crimes. Reporting illegal income as earned legitimately may be illegal money laundering.

Estimates of lost government revenue

U.S. Federal Revenue Lost
to Tax Evasion

Year	Revenue lost (US$ billion)
2010	305
2009	304
2008	357
2007	376
2006	376
2005	314
2004	272
2003	257
2002	269
2001	290
Total revenue lost:	$3.44 trillion

In the United States, the IRS estimate of the 2001 tax gap was $345 billion. For 2006, the tax gap is estimated to be $450 billion.

A more recent study estimates the 2008 tax gap in the range of $450 to $500 billion, and unreported income to be approximately $2 trillion. Thus, 18 to 19 percent of total reportable income is not properly reported to the IRS.

Measurement

Beginning in 1963 and continuing every 3 years until 1988, the IRS analyzed 45,000 to 55,000 randomly selected households for a detailed audit as part of the Taxpayer Compliance Measurement Program (TCMP) in an attempt to measure unreported income and the "tax gap". The program was discontinued in part due to its intrusiveness, but its estimates continued to be used as assumptions. In 2001, a modified random-sampling initiative called the National Research Program was used to sample 46,000 individual taxpayers and the IRS released updated estimates of the tax gap in 2005 and 2006. However, critics point out numerous problems with the tax gap measure. The IRS direct audit measures of noncompliance are augmented by indirect measurement methods, most prominently currency ratio models.

After the TCMP audits, the IRS focused on two groups of taxpayers: those with just a small change in the balance due, and those with a large (over $400) change in the balance due. Taxpayers were further partitioned into "nonbusiness" and "business" groups and each group was divided into five classes based on total positive income. Using line items from the auditor's checksheet, discriminant analysis, and a scoring mechanism, each return was awarded a score, known as a "Z-score". Higher Z-scores were associated by IRS personnel with a higher risk of tax evasion. However, the Discriminant Index Function (DIF) system did not provide examiners with specific problematic variables or reasons for the high score and so each filing had to be manually examined by an auditor.

Investigatory procedures

The IRS may carry out investigations to determine the correctness of any tax return and collect necessary income tax, including requiring the taxpayer to provide specific information such as books, records, and papers. The IRS whistleblower award program was created to assist the IRS in obtaining necessary information. While these investigations can lead to criminal prosecution, the IRS itself has no power to prosecute crimes. The IRS can only impose monetary penalties and require payment of proper tax due. The IRS performs audits on suspicion of noncompliance but has also historically performed randomly selected audits to estimate total noncompliance; the former audits have much higher chance of noncompliance.

Net worth and cash expenditure methods of proof

Under the net worth and cash expenditure methods of proof, the IRS performs year-by-year-by-year comparisons of net worth and cash expenditures to identify under reporting of net worth. While the net worth method and the cash accrual method may be used separately, they are often used in conjunction with one another. Under the net worth method, the IRS chooses a year to determine the taxpayer's opening net worth at year's end. This provides a snapshot of the taxpayer's net worth at a particular point in time. 

The snapshot includes the taxpayer's cash on hand, bank accounts, brokerage (stocks and bonds), house, cars, beach house, jewelry, furs, and other similar items. Generally the IRS learns about these items through very thorough and in-depth investigations, sometimes casing the suspected fraudulent taxpayer. In addition, the IRS also assesses the taxpayer's liabilities. Liabilities include expenses such as the taxpayer's mortgage, car loans, credit card debts, student loans, and personal loans. The opening net worth is the most critical point at which the IRS must assess the taxpayer's assets and liabilities. Otherwise, the net worth comparison will be inaccurate.

The IRS then evaluates new debts and liabilities accumulated in the next year, and assesses the taxpayer's new net worth at the next year's end. In addition, the IRS reviews the taxpayer's cash expenditures throughout the tax year. The IRS then compares the increase in net worth and the cash expenditures with the reported taxable income over time in order to determine the legitimacy of the taxpayer's reported income. 

The net worth method was first used in the case of Capone v. United States. The cash method was approved in 1989 in United States v. Hogan.

Bank deposit cash expenditure method

First approved by the Eighth Circuit in 1935 in Gleckman v. United States, the bank deposit cash expenditure method identifies tax evasion through review of the taxpayer's bank deposits. This method of investigation primarily focuses on whether the taxpayer's total bank deposits throughout the year are equal to the taxpayer's reported income. This method is most appropriate when the majority of the taxpayer's income is deposited in the bank and most expenses are paid by check.

This method is most commonly used for surveillance of tipped employees and is combined with statistical analysis to determine what a tipped employees actual wages are. Information gathered through this method is most successful when the credibility of tipped employees can be destroyed. This method is used less frequently now for tipped employees because the IRS negotiates with hotels or casinos, the largest employers of tipped employees, to identify a tip estimate. If the tipped employee reports the minimal amount agreed upon, he is not questioned by the IRS. However, it is recommended for corroborating other methods of proof. Given the uncertainty of this method, this method likely could not be used in criminal prosecutions where the guilt must be found beyond a reasonable doubt.

Whistleblower program

In addition to the methods of proof the IRS has developed, the Tax Relief and Health Care Act of 2006 created the IRS Whistleblower Office, which allows anonymous whistle blowers to receive 15 to 30 percent of any recovery by the IRS which comes to at least $2 million including all penalties, interests and any other monies collected from the government. The whistle blower program seeks information based on evidence and analysis which can provide a solid basis for further investigation rather than speculation and hearsay.

The program is designed to provide incentive to ordinary citizens to inform on tax cheats. The program provides far greater incentives for whistle blowers than previous programs because under prior programs the government was not required to compensate whistleblowers. Under this program, a taxpayer may file a lawsuit in court if he or she does not receive a deserved award.

Historical U.S. tax evasion cases

The IRS publishes the number of civil and criminal penalties in the IRS Data Book (IRS Publication 55B) and makes these available online. Table 17 shows tabulated data on civil penalties and Table 18 shows data on criminal investigations. In 2012, the IRS assessed civil penalties in 37,910,493 cases and 4,994,926 abatements. In 2012, the IRS initiated 5,125 investigations; of 3,701 which were referred to prosecution, 2,634 resulted in conviction. The agency also highlights current investigations on its website by various categories, including abusive returns, tax schemes, corporate fraud, money laundering, and various other categories.

• 1932–1939: Al Capone served seven years of an 11-year sentence in federal prison on Alcatraz Island for tax evasion. He was let out of jail early while suffering with the advanced stages of syphilis.
• 1933: Gangster Dutch Schultz was indicted for tax evasion. Rather than face the charges, he went into hiding.
• U.S. President Harry Truman pardoned George Caldwell, George Berham Parr, and Seymour Weiss for income tax evasion.
• 1963: Joe Conforte, a brothel owner, served two and a half years in prison, convicted for the crime of income tax evasion.
• 1971: Martin B. McKneally (R-NY) was placed on one-year probation and fined $5,000 for failing to file income tax return. He had not paid taxes for many years prior.
• 1972: Cornelius Gallagher (D-NJ) pleaded guilty to tax evasion, and served two years in prison.
• 1974: Otto Kerner Jr. (D) - Resigned as a judge of the Federal Seventh Circuit Court District after conviction for bribery, mail fraud, and tax evasion while Governor of Illinois. He was sentenced to 3 years in prison and fined $50,000.
• 1982: Frederick W. Richmond (D-NY) was convicted of tax evasion and possession of marijuana. Served 9 months
• 1985: Joseph Alioto, a lawyer, confessed that he paid no income taxes during the years he served as Mayor of San Francisco.
• 1985–1986: Iran–Contra Affair - Thomas G. Clines was convicted of four counts of tax-related offenses for failing to report income from the operations.
• 1987: Robert Bernard Anderson (R) former United States Secretary of Treasury (1957–1961) pleaded guilty to tax evasion while operating an offshore bank.
• 1986: Harry Claiborne, Federal District court Judge from Nevada, was impeached by the House and convicted by the Senate on two counts of tax evasion. He served over a year in prison.
• 1991: Harry Mohney, founder of the Déjà Vu strip club chain, began to serve three years in prison for tax evasion.
• "Matty the Horse" Ianniello (Mafia) was sent to prison for income tax evasion.
• 1992: Catalina Vasquez Villalpando (R), Treasurer of the United States, pleads guilty to obstruction of justice and tax evasion.
• 1993: Sam Roti, nephew of Chicago alderman Fred Roti, was indicted on Federal tax charges, which were later dropped.
• Nicolas Castronuovo is the owner of the Florida pizza parlor where Senator Robert Torricelli was caught on an FBI wiretap soliciting contributions in 1996. Nicolas Castronuovo and his grandson Nicholas Melone later pleaded guilty to evading the government of $100,000 in taxes.
• 1995: Webster Hubbell, (D) Associate Attorney General, pleaded guilty to mail fraud and tax evasion. He is sentenced to 21 months in prison.
• 1996: Heidi Fleiss was convicted of federal charges of tax evasion and sentenced to 7 years in prison. After two months she was released to a halfway house, with 370 hours of community service.
• 2001: U.S. President Bill Clinton pardoned Marc Rich and Pincus Green, indicted by U.S. Attorney on charges of tax evasion and illegal trading with Iran. President Clinton also pardons Edward Downe, Jr., for wire fraud, filing false income tax returns, and securities fraud.
• 2002: James Traficant (D-OH) was convicted of ten felony counts including bribery, racketeering and tax evasion and sentenced to 8 years in prison.
• 2002: The Christian Patriot Association, an "ultra-right-wing group", was shut down after convictions for tax fraud and tax evasion.
• 2005: Duke Cunningham (R-CA) pleaded guilty to charges of conspiracy to commit bribery, mail fraud, wire fraud and tax evasion in what came to be called the Cunningham scandal. He is sentenced to over eight years.
• 2006: Jack Abramoff, lobbyist, was found guilty of conspiracy, tax evasion and corruption of public officials in three different courts in a wide-ranging investigation. Now serving 70 months and fined $24.7 million
• 2008: Charles Rangel (D-NY) failed to report $75,000 income from the rental of his villa in Punta Cana in the Dominican Republic and was forced to pay $11,000 in back taxes. The House of Representatives voted 333–79 to censure Rangel. It had been 27 years since the last such measure and Rangel was only the 23rd House member to be censured.
• 2008: Senator Ted Stevens (R-AK) was convicted on 7 counts of bribery and tax evasion just prior to the election. He continued his run for re-election, but lost. However, prior to sentencing, the indictment was dismissed—effectively vacating the conviction—when a Justice Department probe found evidence of gross prosecutorial misconduct.
• 2013: Big Four accounting firm Ernst & Young agreed to pay federal prosecutors $123 million to settle criminal tax avoidance charges stemming from $2 billion in unpaid taxes from about 200 wealthy individuals advised by four Ernst & Young senior partners between 1999 and 2004.

Redistribution of income and wealth

From Wikipedia, the free encyclopedia

German progressive tax rates for different incomes. Progressive tax systems require the rich to pay taxes at higher rates, to make it possible to raise larger total sums to pay for governmental functions. Some argue such systems are primarily for wealth redistribution.

 

Redistribution of income and redistribution of wealth are respectively the transfer of income and of wealth (including physical property) from some individuals to others by means of a social mechanism such as taxation, charity, welfare, public services, land reform, monetary policies, confiscation, divorce or tort law. The term typically refers to redistribution on an economy-wide basis rather than between selected individuals. 

Interpretations of the phrase vary, depending on personal perspectives, political ideologies and the selective use of statistics. It is frequently heard in politics, usually referring to perceived redistributions from those who have more to those who have less. Occasionally, however, it is used to describe laws or policies that cause opposite redistributions that shift monetary burdens from wealthy to low-income individuals.

The phrase can be emotionally charged and used to exaggerate or misconstrue the motivations of opponents during political debates. For example, if an individual politician calls for increased taxes on higher income individuals, their sole focus may be to raise funds for specific government programs, tapping the largest available sources while realizing that low-wage workers have little or no excess income to draw tax revenues from. Political opponents might argue that this politician's prime motivation is to redistribute wealth, when redistribution is not their goal.

The phrase is often coupled with the term "class warfare," with high income earners and the wealthy portrayed as victims of unfairness and discrimination.

Redistribution tax policy should not be confused with predistribution policies. "Predistribution" is the idea that the state should try to prevent inequalities occurring in the first place rather than through the tax and benefits system once they have occurred. For example, a government predistribution policy might require employers to pay all employees a living wage, not just a minimum wage, as a "bottom-up" response to widespread income inequalities or high poverty rates.

Many alternate taxation proposals have been floated without the political will to alter the status quo. One example is the proposed "Buffett Rule", which is a hybrid taxation model composed of opposing systems, intended to minimize the favoritism of the special interest tax design. 

The effects of a redistribution system are actively debated on ethical and economic grounds. The subject includes analysis of its rationales, objectives, means, and policy effectiveness.

History

In ancient times, redistribution operated as a palace economy. These economies were centrally based around the administration, so the dictator or pharaoh had both the ability and the right to say who was taxed and who got special treatment.

Another early form of wealth redistribution occurred in Plymouth Colony under the leadership of William Bradford. Bradford records in his diary that this "common course" bred confusion, discontent, distrust, and the colonists looked upon it as a form of slavery.

A closely related term, distributism (also known as distributionism or distributivism), is an economic ideology that developed in Europe in the late 19th and early 20th century based upon the principles of Catholic social teaching, especially the teachings of Pope Leo XIII in his encyclical Rerum novarum and Pope Pius XI in Quadragesimo anno. More recently, Pope Francis in his Evangelii Gaudium, echoed the earlier Papal statements.

Role in economic systems

Different types of economic systems feature varying degrees of interventionism aimed at redistributing income, depending on how unequal their initial distributions of income are. Free-market capitalist economies tend to feature high degrees of income redistribution. However, Japan's government engages in much less redistribution because its initial wage distribution is much more equal than Western economies. Likewise, the socialist planned economies of the former Soviet Union and Eastern bloc featured very little income redistribution because private capital and land income – the major drivers of income inequality in capitalist systems – was virtually nonexistent; and because the wage rates were set by the government in these economies.

Modern forms of Redistribution

It is inevitable, the redistribution of wealth and its practical application, taxation, are bound to change with the continuous evolution of social norms, politics, and culture. Within developed countries income inequality has become a widely popular issue that has dominated the debate stage for the past few years. The importance of a nation’s ability to redistribute wealth in order to implement social welfare programs, maintain public goods, and drive economic development has brought various conversations to the political arena. A country’s means of redistributing wealth comes from the implementation of a carefully thought out well described system of taxation. The implementation of such a system would aid in achieving the desired social and economic objective of diminishing social inequality and maximizing social welfare. There are various ways to impose a tax system that will help create a more efficient allocation of resources, in particular, many democratic, even socialist governments utilize a progressive system of taxation to achieve a certain level of income redistribution. In addition to the creation and implementation of these tax systems, “globalization of the world economy [has] provided incentives for reforming the tax systems” across the globe. Along with utilizing a system of taxation to achieve the redistribution of wealth, the same socio-economic benefit could be achieved if there are appropriate policies enacted within current political infrastructure that addresses these issues. Modern thinking towards the topic of the redistribution of wealth, focuses on the concept that economic development increases the standard of living across an entire society. 

Today, income redistribution occurs in some form in most democratic countries through economic policies. Some redistributive policies attempt to take wealth, income, and other resources from the “haves” and give them to the “have-nots,” but many redistributions go elsewhere. 

In his article Redistribution, Dwight R. Lee states: 

“…most government transfers are not from the rich to the poor. Instead, government takes from the relatively unorganized (e.g., consumers and general taxpayers) and gives to the relatively organized (groups politically organized around common interests, such as the elderly, sugar farmers, and steel producers). The most important factor in determining the pattern of redistribution appears to be political influence, not poverty. “ “The direct transfer of cash and services is only one way that government transfers income. Another way is by restricting competition among producers. The inevitable consequence—indeed, the intended consequence—of these restrictions is to enrich organized groups of producers at the expense of consumers. Here, the transfers are more perverse than with Medicare and Social Security. They help relatively wealthy producers at the expense of relatively poor (and, in some cases, absolutely poor) consumers. Many government restrictions on agricultural production, for example, allow farmers to capture billions of consumer dollars through higher food prices (see agricultural subsidy programs). Most of these dollars go to relatively few large farms, whose owners are far wealthier than the average taxpayer and consumer (or the average farmer). Also, wealthy farmers receive most of the government’s direct agricultural subsidies."

Some consider the U.S. government’s progressive-rate income tax policy as redistributive, because some of the tax revenue goes to social programs such as welfare and Medicare.

In a progressive income tax system, a high income earner will pay a higher tax rate (a larger percentage of their income) than a low income earner; and therefore, will pay more total dollars per person.

Other taxation-based methods of redistributing income are the negative income tax for very low income earners and tax loopholes (tax avoidance) for the better-off. 

Two other common types of governmental redistribution of income are subsidies and vouchers (such as food stamps). These transfer payment programs are funded through general taxation, but benefit the poor or influential special interest groups and corporations. While the persons receiving transfers from such programs may prefer to be directly given cash, these programs may be more palatable to society than cash assistance, as they give society some measure of control over how the funds are spent.

It has been argued that the U.S. Social Security program redistributes income from the rich to the poor, but the majority of those receiving Social Security earned their benefits through tax withholding from their paychecks or quarterly income statements, and most benefits are indexed to the actual earning levels of individual workers. Only the highest- and lowest-income workers fall outside normal rates. In addition, Social Security deductions are only taken from the first $200,000 in income, with nothing further taken from higher incomes over that amount. In other words, a person who earns $100 million a year pays the same Social Security tax as another worker who earns $200,000 a year. 

Contrary to popular belief, a recent study found that, overall, the Social Security System was slightly regressive against the poor and not redistributive, once important factors were taken into account (for example, the longer life expectancy of the wealthy when compared to the poor gives them more years to collect benefits). 

Governmental redistribution of income may include a direct benefit program involving either cash transfers or the purchase of specific services for an individual. Medicare is one example. Medicare is a government-run health insurance program that covers people age 65 or older, certain younger people with disabilities, and people with end-stage renal disease (permanent kidney failure requiring dialysis or a transplant, sometimes called ESRD). This is a direct benefit program because the government is directly providing health insurance for those who qualify.

The difference between the Gini index for the income distribution before taxation and the Gini index after taxation is an indicator for the effects of such taxation.

Wealth redistribution can be implemented through land reform that transfers ownership of land from one category of people to another, or through inheritance taxes or direct wealth taxes. Before-and-after Gini coefficients for the distribution of wealth can be compared.

Objectives

The objectives of income redistribution are to increase economic stability and opportunity for the less wealthy members of society and thus usually include the funding of public services.

One basis for redistribution is the concept of distributive justice, whose premise is that money and resources ought to be distributed in such a way as to lead to a socially just, and possibly more financially egalitarian, society. Another argument is that a larger middle class benefits an economy by enabling more people to be consumers, while providing equal opportunities for individuals to reach a better standard of living. Seen for example in the work of John Rawls, another argument is that a truly fair society would be organized in a manner benefiting the least advantaged, and any inequality would be permissible only to the extent that it benefits the least advantaged. 

Some proponents of redistribution argue that capitalism results in an externality that creates unequal wealth distribution.

Some argue that wealth and income inequality are a cause of economic crises, and that reducing these inequalities is one way to prevent or ameliorate economic crises, with redistribution thus benefiting the economy overall. This view was associated with the underconsumptionism school in the 19th century, now considered an aspect of some schools of Keynesian economics; it has also been advanced, for different reasons, by Marxian economics. It was particularly advanced in the US in the 1920s by Waddill Catchings and William Trufant Foster. There is currently a great debate concerning the extent to which the world's extremely rich have become richer over recent decades. Thomas Piketty's Capital in the Twenty-First Century is at the forefront, critiqued in certain publications such as The Economist.

Moral obligation

Peter Singer's argument contrasts to Thomas Pogge's in that he states we have an individual moral obligation to help the poor.

Economic effects of inequality

Number of high-net-worth individuals in the world in 2011

 

Using statistics from 23 developed countries and the 50 states of the US, British researchers Richard G. Wilkinson and Kate Pickett show a correlation between income inequality and higher rates of health and social problems (obesity, mental illness, homicides, teenage births, incarceration, child conflict, drug use), and lower rates of social goods (life expectancy, educational performance, trust among strangers, women's status, social mobility, even numbers of patents issued per capita), on the other. The authors argue inequality leads to the social ills through the psychosocial stress, status anxiety it creates.

A 2011 report by the International Monetary Fund by Andrew G. Berg and Jonathan D. Ostry found a strong association between lower levels of inequality and sustained periods of economic growth. Developing countries (such as Brazil, Cameroon, Jordan) with high inequality have "succeeded in initiating growth at high rates for a few years" but "longer growth spells are robustly associated with more equality in the income distribution."

Criticism

Public choice theory states that redistribution tends to benefit those with political clout to set spending priorities more than those in need, who lack real influence on government.

The socialist economists John Roemer and Pranab Bardhan criticize redistribution via taxation in the context of Nordic-style social democracy, reportedly highlighting its limited success at promoting relative egalitarianism and its lack of sustainability. They point out that social democracy requires a strong labor movement to sustain its heavy redistribution, and that it is unrealistic to expect such redistribution to be feasible in countries with weaker labor movements. They point out that, even in the Scandinavian countries, social democracy has been in decline since the labor movement weakened. Instead, Roemer and Bardhan argue that changing the patterns of enterprise ownership and market socialism, obviating the need for redistribution, would be more sustainable and effective at promoting egalitarianism.

Marxian economists argue that social democratic reforms – including policies to redistribute income – such as unemployment benefits and high taxes on profits and the wealthy create more contradictions in capitalism by further limiting the efficiency of the capitalist system via reducing incentives for capitalists to invest in further production. In the Marxist view, redistribution cannot resolve the fundamental issues of capitalism – only a transition to a communist economy can.