Paul L. Caron
Dean




Thursday, October 23, 2008

The Rich Cheat More on Their Taxes

Andrew Johns (IRS) & Joel Slemrod (Ross School of Business, University of Michigan) have posted The Distribution of Income Tax Noncompliance on the Michigan website.  Here is the abstract:

New research by OTPR Director Joel Slemrod and IRS employee Andrew Johns looks at income tax noncompliance by income group. It makes use of newly available data for tax year 2001 from the IRS’s most recent comprehensive study of individual income tax noncompliance, the National Research Program. The study finds that, when taxpayers are arrayed by their “true” income, defined as reported income adjusted for the underreporting estimated by the IRS tax gap methodology, the ratio of aggregate misreported income to true income generally increases with income, although it peaks among taxpayers with adjusted gross income between $500,000 to $1,000,000, and is lower than the peak ratio for individuals with income above $1,000,000. In sharp contrast, though, the ratio of underreported tax to true tax is highest for lower-income taxpayers. This contrast in results reflects the fact that under a graduated tax schedule a given percentage reduction in taxable income corresponds to a higher percentage reduction in tax liability the lower is a taxpayer’s income. Much, but not all, of the distributional pattern of noncompliance is related to the fact that on average high-income taxpayers receive their income in forms that have higher noncompliance rates.

The paper is extensively discussed in Forbes:  Rich Cheat More on Taxes, New Study Shows:

A new study based on unpublished IRS data shows the rich are different when it comes to paying taxes: They hide more of their income.

The previously unreported study estimates that taxpayers whose true income was between $500,000 and $1 million a year understated their adjusted gross incomes by 21% overall in 2001, compared to an 8% underreporting rate for those earning $50,000 to $100,000 and even lower rates for those earning less. (The "net misreporting rate" as the IRS calls it, includes both underreported income and inflated deductions.)

In all, because of their higher noncompliance rates, those with true incomes of $200,000 or more received 25% of all income, but accounted for 40% of net underreported income and 42% of underreported tax in 2001, the new analysis finds.

From Portfolio.com:

Misreport_3

   

 

 

 

 

 

 

          

https://taxprof.typepad.com/taxprof_blog/2008/10/the-rich-cheat.html

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» Biggest tax cheats? The rich from Don't Mess With Taxes
Three guesses as to which group of taxpayers cheat on their taxes more and the first two don't count. Yep, the wealthy are more adept than the rest of us at hiding their income from the IRS.That's the considered opinion of Joel Slemrod, economics profe... [Read More]

Tracked on Nov 2, 2008 6:00:05 AM

Comments

What about a study on practically societal accepted "under the table income".
How many union employees in the construction trades (don't forget school teachers in the summertime) collect unemployment, some of who mention their outside unreported income while collecting, or outside work on weekends when not collecting? The general public would be surprised to hear about their employment packages including
liberal annuity contributions besides having very generous pensions. And as to the lefties currently calling for increased federal contributions towards infrastructure to help the economy, don't forget project labor agreements which drastically increase the costs of public projects, especially school buildings. Or the arbitrary demolition of historic buildings built with 4 withe bricks and practically unattainable virgin forest tree wood and usually structurally sound built using redundant engineering standards. "Don't ya know it's more expensive to renovate and update an old building!"

Posted by: dr | Oct 25, 2008 9:57:21 AM

Actually, if you read the paper, you discover that the data shows that the poor are far more likely to "cheat on their taxes." The rich are more likely to cheat by using the particular method of misrepresenting their AGI, which is the focus of the majority of the paper. But the poor are far more likely to misreport their final tax after accounting for refundable credits (60% or more of those earning AGI from 0 to 10k are cheaters.) But that just doesn't sell a "soak the rich" headline, does it.

Posted by: Not so fast | Oct 24, 2008 11:06:59 AM

Either the people at Portfolio.com didn't read the paper or they didn't take its admonition seriously: "Table 3 also shows how misleading it can be to draw conclusions about the distribution of tax noncompliance based on reported AGI."

The paper itself is clear and not politically slanted. Misreporting of taxable income has many facets, and the paper shows them all.

The popular media wrote a simplistic and slanted version to match the mental capacity and political leanings of its writers and readers. Yawn.

Incidentally, the graph shown here is from Table 2. As some posters here suspected, the authors chose to graph the column of Table 2 that excludes refundable credits. The adjacent column includes these credits, such as EITC. Want to guess what it shows? Noncompliance is 70% at the lowest incomes, flattening out at about 15% above $30k. That wasn't the story the media authors wanted to tell. The academic paper presents both facets, but the media shows you only one.

Posted by: AMTbuff | Oct 24, 2008 10:02:21 AM

Going along with the veal calf guy, the lowest-income people actually have an incentive to inflate their income (i.e. over-report) in order to maximize some benefits they receive, such as EITC. I think that generally applies to everyone making under $15k.

Posted by: higher income | Oct 24, 2008 5:42:11 AM

As Lee Shepard noted commenting on one of the Son-of-BOSS cases, there is no tax to low to evade. In that case the tax being avoided was at a 20% rate. The incentive to cheat isn't about rates.

Posted by: no tax to low to evade | Oct 24, 2008 4:41:26 AM

Shocked! I am shocked some people avoid taxes.

Interesting. With this information and information about the international tax gap and the recent flurry about offshore tax havens and secret bank accounts, maybe the rich are hiding there money offshore?

Bill Lowrance
Lowrance Law LLC

Posted by: Bill Lowrance | Oct 24, 2008 3:40:00 AM

Professor Slemrod is scheduled to participate in the Stanford Law & Policy Review symposium on "Closing the Tax Gap" to be held November 8 at Stanford.

Details can be found here:

http://taxprof.typepad.com/taxprof_blog/2008/10/stanford-sympos.html

Posted by: WD Kebschull | Oct 23, 2008 9:12:48 PM

I haven't read the underlying reports, but many lower-income taxpayers cheat because income eligibility on benefits (subsidized child care, medi-cal, EIC, tuition, etc). Were those costs included in the percentage calculations?

Posted by: guy in the veal calf office | Oct 23, 2008 5:54:50 PM

when you try to take more of each dollar made, there is more incentive to hide that dollar.

Posted by: | Oct 23, 2008 5:20:19 PM

Eat the Rich. No seriously, kill them and eat them. But make sure you reinstate the Estate Tax first. Two birds, one fork.

Posted by: Not Rich | Oct 23, 2008 2:09:55 PM

The chart might be a little more revealing if it talked about the amount of tax avoided, rather than the amount of income misstated. As shown, it actually underreports the extent to which this is a rich-person phenomenon: the return on investment for underreporting $1 of income would be three times higher for the richest taxpayers than for the poorest.

Posted by: taxrascal | Oct 23, 2008 1:52:43 PM

What a shock! Who knew?
I lecture nationwide for Gear Up Tax Seminars, and I've been speaking about how the IRS believes, from their deeply flawed 1040 NRP data, that all of the hidden income is in the returns of Schedule C filers and the small taxpayer. There was a recent conference held of the East Coast bigwigs, to the same effect.
Major corporate audits are way down and instead the little person is being squeezed. The IRS has put its resources going after areas where there is very little.
Remember the question, "Why do you rob banks?" (It is an old concept, I'll agree, but banks once had money). And the response is: "That is where the money is at."
I don't mean to be simplistic, but when research backs up pithy quotes, you've got the truth at hand.

Posted by: Abe Carnow | Oct 23, 2008 12:37:17 PM