Behavioural Responses to Taxes and Measures of the Tax Gap

Transcription

1 Behavioural Responses to Taxes and Measures of the Tax Gap Norman Gemmell Chair in Public Finance, Victoria Business School Victoria University of Wellington and John Hasseldine Paul College, University of New Hampshire

2 Outline Tax Gap : Background and Definitions Purpose of Tax Gap Estimates Some Tax Gap Estimates Issues in Measuring Tax Gaps Assessment of Tax Gap Measures Tax Gap Estimates & Behavioural Responses

3 Key points to take away 1) Don t rely on ANY estimates of the overall hidden economy 2) Direct tax gap estimates based on aggregate approaches are likely to have very big margins of error 3) Estimates based on micro tax data, especially from random sampling are potentially more reliable 4) But ALL tax gap measures are flawed, in principle and in practice, by ignoring taxpayers tax base responses to compliance efforts 5) Don t use any tax gap measures for annual performance evaluations (or rewards/penalties) of IRD staff!

4 Background Many countries estimate VAT/GST tax gaps (e.g. UK since 1992) The IMF is currently preparing a new method of measuring VAT gaps for roll-out to member countries in 2013 ( RA-GAP ) For direct taxes: there are no reliable estimates of the overall tax gap Dawn Primarolo (UK Paymaster General, March 2004): Lord Grabiner QC and the OECD have both concluded that it is a concept difficult if not impossible to measure But: from 2009, UK has estimated the direct tax gap (highly politicised and subject to disagreement)

5 Definitions IRS the difference between the tax that taxpayers should pay and what they actually pay on a timely basis HMRC: the difference between tax collected and that, which in HMRC s view, should be collected. Tax liability is therefore defined so as to include all tax that is due under either the letter or the spirit of the law. HMRC: Under this definition the tax gap revenue loss equates to the shortfall resulting from fraud, error, non-payment and artificial avoidance schemes

6 Definitions (HMRC) Theoretical Tax Liability Actual Tax Receipts = Tax Gap

7 The IMF s Tax Gap Approach Potential Administrative Effectiveness 100% Current Administrative Effectiveness C B A Tax Gap Compliance Gap Actual Collections G F D Current Tax Structure Tax Expenditures Policy Gap H I E 100% Potential Tax Structure

8 Purpose of Tax Gap Estimates Why measure the tax gap? Performance evaluation of tax agency Benchmark performance against other revenue authorities Assist compliance risk management quantify, compare, and prioritise responses to risk across the tax system U.S. (Federal + several states), U.K., Sweden, Denmark officially measure direct tax gaps Many more countries measure indirect (e.g. VAT) tax gaps

9 Tax Gap Estimates

10 HMRC s UK Tax Gap Estimates Tax Gaps by Tax 2008/09 14% 12% 10% 8% 6% 4% 2% 0% VAT Excises IT/NICS/CGT CT

11 HMRC s UK Tax Gap Estimates VAT Gap 16% 14% 12% 10% 8% 6% 4% 2% 0% 2002/ / / / / /08 VAT Gap VAT Gap. less MTIC

12 VAT Gap HMRC s UK Tax Gap Estimates VAT gap estimates by year of publication 18% 17% 16% 15% 14% 13% 12% 11% 10% 9% 8%

13 US Tax Gap Estimates Study Estimate in Current Estimate in Percent of Year Dollars (billion) GDP IRS (various) Feige (1994) Tanzi (1982, 1983) Bureau of Economic Analysis (1993) US Dept of Labor IRS (2005) (% of tax rev) IRS (2006) IRS (2012) 345 (gross)** 290 (net) 450 (gross) 385 (net) 16.3 (% of tax rev) 13.7 (% of tax rev) 16.9 (% of tax rev) 14.5 (% of tax rev) Note: * See Cebula and Paul (2000) for references in this table. ** Compares to $311 billion using rules from 1988 and earlier IRS studies. Source: Adapted from Cebula and Paul (2000), and IRS (2005, 2006, 2012).

14 US Tax Gap Estimates

15 Measurement Issues Conventional approach - 2 methods to identify theoretical tax liability: Recorded economic activity The tax system Tax Revenue 2 Unrecorded economic activity 1 Potential Tax Revenue But: Neither approach typically allows for tax base responses to changes in compliance effort/success.

16 Conventional Measurement Approaches Micro approaches: 1. taxpayer auditing / compliance 2. taxpayer surveys Macro approaches: 3. national income-expenditure discrepancy 4. national income-revenue discrepancy 5. single indicator models (labour force, transactions, currency, electricity) 6. multiple indicator (MIMIC) methods 2 1

17 Assessment of Conventional Approaches (1) Micro approaches 1. taxpayer auditing / compliance 2. taxpayer surveys These methods are direct and require randomised audit/survey methods or suitable weighting factors if risk-based criteria are used Expensive to implement Cannot capture behavioural responses of tax base to compliance effort

18 Assessment of Conventional Approaches (2) Macro approaches - Discrepancy methods: 3. national income-expenditure discrepancy 4. national income-fiscal discrepancy The U.K. VAT gap uses 3. But more difficult for direct taxes (income data derived from tax return data!) Only crude estimates of the size (and growth) of the hidden (and taxable) income can be estimated. Year on year changes are more likely to reflect measurement error and other factors than changes in hidden income. E.g. UK ONS data revisions reduce VAT gap by 10%.

19 Assessment of Conventional Approaches (3) Macro approaches: 5. Single Indicator methods Assume link between hidden income and some variable (labour force, retail transactions, currency, electricity etc). The trend in the latter proxies the level/growth of hidden income Weaknesses: Anchoring the size of hidden income requires no hidden income at some point or relationship between the two is known Also, change in proxy variable over time is assumed entirely due to changes in hidden income

20 Assessment of Conventional Approaches (4) Macro approaches: 6. Multiple Indicator (MIMIC) methods - e.g. Bajada and Schneider (2005) Assume hidden economy is captured by at least two indicator variables and two or more causal or latent variables. Has been a popular approach: Giles-Tedds, Schneider-Bajada Breusch shows: these estimated variables can t determine the size of the shadow economy one of them tends to drive time-series variation (and it s not tax!) the index is sensitive to the units of measurement of the causal & indicator variables Implausible results: e.g. Canadian shadow economy apparently grew by a factor of 7 over 20 years while GDP doubled?

21 Bajada and Schneider (2005) Causal variables Latent variable Indicator variables

22 Tax Gap Measures and Behavioural Responses

23 Tax Gaps and Behavioural Responses Tax gap measures based on presumption/evidence that taxpayers alter their behaviour in response to tax (rates, exemptions etc) tax evasion But: compliance effort increases the effective tax rate Tax Gap ignores behavioural response of the tax base to compliance effort: i.e. reductions in the tax gap. Revenue = tax rate x tax base But tax base = f(tax rate) potential collections shrink Potential Administrative Effectiveness 100% Current Administrative Effectiveness C B A Tax Gap Actual Collections Tax Gap Tax gap Compliance Gap Actual Collections Potential Collections G F D Current Tax Structure Tax Expenditures Policy Gap H I E 100%

24 Tobacco Excise Example 1 $3 Sales $3 million Tax Revenue $1 million ½ million $2 Missing Tax Revenue $ ½ million Tax gap $½ million 33% (0.5/1.5). But: Many cigarettes purchased illegally at $2 will no longer be bought when successful compliance effort pushes up the price to $3. i.e. Anyone who values cigarettes between $2 and $3 will smoke less If smuggled cigarette sales cut in half when extra $1 tax applied to all (& formerly legal cigarettes unaffected): True tax gap = $250,000. i.e. only half of conventional tax gap depends on which taxpayers respond to changes in compliance effort.

25 Tobacco Excise & Demand for Cigarettes With full tax compliance, revenue equals the area ABCD raised from a tax base of OQ 1. But smuggling sales as high as OQ 2 : Q 1 Q 2 illegal Conventional tax gap = the area BHEC / ABCD BUT: which smokers are buying the smuggled cigarettes: O Q 1. or Q 1 Q 2? True tax gap between $0 and $½ million

26 More Generally... t = statutory tax rate = compliance rate (1 = full compliance) t = effective tax rate Tax t = 1 t falls Total tax revenue = $0 when effective tax rate t equals 0 (at X ) or 1 (at O ) T = tb* O 45 o Tax Base, B * X t = 0

27 More Generally... t = statutory tax rate = compliance rate (1 = full compliance) t = effective tax rate Tax E D C Conventional tax gap True tax gap A J B Z T * 1 = t 1 B* ( 1 = 1) W T 1 = 1 t 1 B* T = tb*( t) A tax rate of t 1 gives total expected revenue at A, actual revenue at B with compliance: 1 < 1: Conventional tax gap = AB = CE But increased compliance to 100% ( 1 = 1) reduces the tax base and revenue to point J. True tax gap = CD O B * 1 Tax Base, B *

28 More Generally... t = statutory tax rate = compliance rate (1 = full compliance) t = effective tax rate Tax T * 2 = t 2 B* ( 1 = 1) F T * 1 = t 1 B* ( 1 = 1) A T 2 = 1 t 2 B* Depending on how big the tax base response to compliance is... The post-compliance effort tax revenue could be equal to or less than the preeffort revenue (B L K...) C K L B G T 1 = 1 t 1 B* T = tb*( t) O B * 2 Tax Base, B * B * 1

29 Conclusions Key take-aways 1) Don t rely on ANY estimates of the overall hidden economy 2) Direct tax gap estimates based on macro approaches are likely to have very big margins of error 3) Estimates based on micro tax data, especially from random sampling are likely to be more reliable 4) But ALL tax gap measures are flawed, in principle and in practice, by ignoring taxpayers behavioural responses to compliance efforts 5) Don t use any tax gap measures for annual performance evaluations rewards or penalties of IRD staff!