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Tax evasion, technology, and inequality

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Abstract

Ensuring compliance with the tax laws is an enduring challenge for all governments. However, the methods by which governments enforce the tax laws, and by which individuals and firms evade their taxes, change over time, due at least in part to changing technology. In this paper I examine how changing technology, especially changes driven by the transformation of information into digital formats for use by computers, seems likely to affect tax evasion in the years ahead. I argue that many of these changes in technology will improve the ability of governments to decrease tax evasion, mainly by increasing the flow of information to governments. However, I also argue that these changes in technology will open up new avenues by which some individuals and some firms can evade (and avoid) taxes. At this point it is unclear which trend will dominate, so that the effects of technology on the overall level of tax evasion are uncertain. Even so, I believe that the distributional effects of these technological changes are more predictable, given the differential effects of technology on the abilities of individuals of different levels and types of income to evade their taxes. Indeed, I argue that changing technology will make evasion increasingly difficult for most taxpayers, especially those subject to employer withholding and third party information reporting, but that evasion will be increasingly viable for a small number of taxpayers, especially very high income taxpayers. Regardless of the overall impact of technology on the level of tax evasion, I conclude that the effects of technology will likely increase economic inequality.

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Notes

  1. For a wide-ranging discussion of the challenges that tax evasion presents to governance, see the May 2015 Special Issue of Economics of Governance, “The Shadow Economy, Tax Evasion, and Governance”.

  2. See Alm (2012, 2019), Slemrod (2019), and especially Slemrod and Weber (2012) for recent surveys of the many different approaches to, and difficulties in, measurement. For earlier and still useful discussions of the tax evasion literature, see Cowell (1990) and Andreoni et al. (1998).

  3. More accurately, the ability of firms to shift profits to low tax jurisdictions is a form of legal tax avoidance via “aggressive tax planning” (ATP). An ATP is a tax avoidance transaction that complies with the letter but abuses the spirit of the law. It is typically a sophisticated transaction that includes many steps and uses complex mechanisms. Importantly, it is a transaction that has a limited economic justification, and its true rationale is simply to reduce taxes by exploiting shortcomings, weaknesses, or ambiguities in the tax law via the movement of funds, the construction of fictitious “shell” companies, and the use of financial instruments or entities that are treated differently in different tax jurisdictions. Most commonly, ATPs occur by the use of tax havens, in which profits are shifted from higher to lower tax jurisdictions via such practices as treaty shopping, debt shifting, strategic location of intellectual property, tax deferral, corporate inversions, and, especially, transfer pricing. See Alm (2014) and Alm et al. (2020b) for a discussion of these types of strategies and of government policies to reduce their use.

  4. “Money laundering” is the process of disguising the unlawful source of criminally derived proceeds to make them appear legal, proceeds derived from such sources as illegal arms sales, smuggling, activities of organized crime (e.g., drug trafficking and prostitution), embezzlement, insider trading, bribery, extortion and blackmail, computer fraud schemes, corruption (e.g., “petty” and “grand”), and the like. There are typically three stages involved in money laundering: placement, layering, and integration. See Unger and van der Linde (2015) for a discussion of money laundering strategies and of government policies to combat their use.

  5. The dispersion of technological advances around the is difficult to quantify. As one indicator, an important initiative is the Tax Administration Diagnostic Assessment Tool (TADAT), a collaborative international effort led by various organizations. On a more personal level, I have been involved in many projects in developing countries that have been funded by multiple sources and that have as their overriding goal the improvement of tax administrations via the adoption of modern technology.

  6. See Gupta et al. (2017) for a detailed discussion of digitalization and its effects on government finances.

  7. For a more detailed discussion of some of these developments, focusing especially on their legal aspects, see Alm et al. (2020a).

  8. See Rogoff (2016) for a history of the evolution of currency, along with a detailed analysis of the many ways that large denomination bills facilitate tax evasion.

  9. The literature on cryptocurrencies is growing at an enormous pace. See Adrian and Mancini-Griffoli (2019) for a useful overview, along with again Rogoff (2016) for a discussion of both cash and cryptocurrencies.

  10. See Ponte et al. (2019) and Pagano and Liotine (2020) for recent analyses of the many dimensions of global supply chains.

  11. See Kessler (2018) and Belk et al. (2019) for analyses of the sharing economy.

  12. For an early but still relevant discussion of privacy issues, see Posner (1981). For a more recent analysis, see Thierer (2013).

  13. See Slemrod (2006) and Logue and Slemrod (2008) for analyses of the ways in which biometric information might be used in the design of tax policies.

  14. See a comprehensive analysis of the ways in which “big data” will transform analytics, see Mayer-Schonberger and Cukier (2013). For a recent discussion of the specific transformational impacts on research in economics, see Currie et al. (2020).

  15. See Gandomi and Haider (2018) for an analysis of “deep learning” applied to “big data”.

  16. See Kantardzic (2020) for an encyclopedic analysis of all aspects of data mining.

  17. For example, see Jerry Useem, “How Online Shopping Makes Suckers of Us All”, The Atlantic (May 2017), available online at https://www.theatlantic.com/magazine/archive/2017/05/how-online-shopping-makes-suckers-of-us-all/521448/?utm_source=atl&utm_medium=email&utm_campaign=share.

  18. Note that the IRS has for many years conducted statistical analysis of randomly selected individual tax returns via its “Discriminant Inventory Function” (DIF) scores, in order to target its audits more efficiently (Brown and Mazur 2013). More recently, the IRS has increasingly relied upon extensive use of information returns, a “big data” initiative analyzed using the “deep learning” computer algorithms of the IRS, in order to ensure that individuals are reporting accurately their incomes. More broadly, the IRS has an in-house data-mining division known as Research, Applied Analytics and Statistics, which develops data-driven compliance initiatives and which coordinates with other government enforcement agencies.

  19. For further discussion and analysis, see the articles in the May 2000 issue of the Stanford Law Review, “Symposium: Cyberspace and Privacy: A New Legal Paradigm?”.

  20. See also OECD (2000, 2013).

  21. These information exchanges are intended to provide information to tax administrations in the countries that have agreed to exchange information, thereby reducing the extent of income hidden in offshore accounts. Recent research indicates a mixed impact on offshore deposits of these agreements, sometimes called “Exchange of Information” (EOI) agreements. For example, Beer et al. (2019) estimate that the automatic exchange of information reduces foreign-owned deposits in offshore jurisdictions by 25%. In contrast, they find that exchange of information only upon request has no consistent impact on foreign-owned deposits. Johannesen (2014) and Johannesen and Zucman (2014) find broadly similar results for different agreements. In recent work, Johannesen et al. (2020) estimate that exchange of information efforts initiated in 2008 by the U.S. Internal Revenue Service caused roughly 50 thousand individuals to disclose offshore accounts with a combined value of about USD 100 billion. Even so, the additional tax revenues that were generated were relatively small, or about USD 1 billion.

  22. For example, in April 2018 the California Supreme Court issued a decision in Dynamex Operations West, Inc. V. Superior Court of Los Angeles, a decision that required that all employers classify its workers as employees instead of independent contractors. Then in September 2018 the California State Legislature codified this ruling into law (California Assembly Bill 5 (AB5)). There is now a referendum on the 2020 California ballot that would exempt ride-hailing apps from this law. Other states are waiting to see the outcome of this referendum before enacting similar legislation.

  23. For example, FATCA requires that foreign financial institutions and certain other non-financial foreign entities report on the foreign assets held by their U.S. account holders or be subject to withholding on withholdable payments. FAFT issued 40 recommendations relating to improving national cooperation and coordination, defining money laundering offenses and penalties, defining terrorist financing offenses and sanctions, establishing a framework for improving prevention, establishing a framework for increasing transparence, and improving regulations, among other things. The G20/OECD BEPS project recommends 15 specific actions that are intended to address the tax challenges of the digital economy by such policies as neutralizing the effects of hybrid mismatch arrangements, strengthening controlled foreign company rules, limiting base erosion via interest deductions and other financial payments, preventing treaty abuse, preventing the artificial avoidance of permanent establishment status, assuring that transfer pricing outcomes are in line with value creation, establishing methodologies to collect and analyze data on BEPS, improving dispute resolution mechanisms, and improving transparency. The CRS calls on jurisdictions to obtain information from their financial institutions and to automatically exchange that information with other jurisdictions on an annual basis. More broadly, the “Ten Global Principles” formulated by OECD include actions that: ensure tax offences are criminalized; devise an effective strategy for addressing tax crimes; have adequate investigative powers; have effective powers to freeze, seize, and confiscate assets; put in place an organizational structure with defined responsibilities; provide adequate resources for tax crime investigation; make tax crimes a predicate offence for money laundering; have an effective framework for domestic inter-agency co-operation; ensure that international co-operation mechanisms are available; and protect suspects’ rights.

  24. One article of impeachment against then U.S. President Richard M. Nixon in 1974 charged that he had used the IRS against political opponents. Also, widespread publicity of abuses by individual IRS agents led to Senate hearings in 1997 and eventually to passage in 1998 of the IRS Restructuring and Reform Act of 1998, which (among other things) significantly expanded the office of the Taxpayer Advocate. More recently, IRS officials admitted in 2013 that the IRS had subjected conservative political groups to closer scrutiny in their applications for tax-exempt status than liberal political groups.

  25. See especially Kenny and Winer (2006), Esteller-Moré (2011), Robinson and Slemrod (2012), and Durán-Cabré et al. (2015). Much of this research builds upon the pioneering political economy work of Hettich and Winer (1999) and Persson and Tabellini (2000, 2003). I am indebted to an anonymous referee for this suggestion.

  26. For a comprehensive review and assessment of the literature on the incidence of the corporate income tax, see Auerbach (2006).

  27. For example, see recent work by Saez and Zucman (2019) on a global wealth tax, Clausing et al.(2020) on a global minimum corporate income tax, and Avi-Yonah and Clausing (2019), Mason (2020), and Devereux et al. (2020) on comprehensive reform of international taxation.

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  1. Department of Economics, Tulane University, 6823 St. Charles Avenue, 208 Tilton Hall, New Orleans, LA, 70118-5698, USA

    James Alm

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This paper is based on my keynote address at the 6th Shadow Economy Conference, “Tax Evasion and Economic Inequality”, held at the University of Trento in July 2019. I am grateful to conference participants and especially to conference organizers Amadeo Argentiero, Sandro Casal, Marco Faillo, Azzurra Morreale, Luigi Mittone, and Matteo Ploner for many helpful discussions and comments. I also grateful to the editor and to several anonymous referees for many useful and insightful suggestions.

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Alm, J. Tax evasion, technology, and inequality. Econ Gov 22, 321–343 (2021). https://doi.org/10.1007/s10101-021-00247-w

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