New Technologies and the Evolution of Tax Compliance
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Tulane Economics Working Paper Series New Technologies and the Evolution of Tax Compliance James Alm Joyce Beebe Michael S. Kirsch Tulane Economics Rice University Notre Dame Law School [email protected] Omri Marian Jay A. Soled University of California Rutgers University Irvine Working Paper 2009 September 2020 Abstract Improving tax compliance is a common goal of governments worldwide. The United States is no exception. The size of the nation’s “tax gap” — or the difference between what taxpayers pay in taxes in a timely manner and what they should pay if they fully complied with the tax laws — is hundreds of billions of dollars annually, significantly depriving the nation of much-needed revenue. This paper explores the mixed effects of technological advancements on tax compliance — and, thus, its counterpart, tax noncompliance. On the one hand, technological advances have largely eradicated many of the commonplace tax-noncompliance techniques that once reigned during the twentieth century. On the other hand, many of these very same technological advances threaten to usher in new modes of tax evasion. Which of these emergent trends will dominate is unclear. The outcome will largely depend upon whether Congress updates the tax laws to address technological advances and grants sufficient funding to the Internal Revenue Service to maintain robust enforcement efforts in an ever-changing technological landscape. Failure to take these steps will destine the size of the tax gap to expand. Many prior studies have addressed discreet effects of specific technologies on tax compliance. This paper contributes to this developing literature by offering a cohesive framework to address technological advancement and tax compliance. Keywords: Technology, Tax compliance, Tax gap. JEL codes: H24, H26. NEW TECHNOLOGIES AND THE EVOLUTION OF TAX COMPLIANCE James Alm, Joyce Beebe, Michael S. Kirsch, Omri Marian, and Jay A. Soled* Improving tax compliance is a common goal of governments worldwide. The United States is no exception. The size of the nation’s “tax gap” — or the difference between what taxpayers pay in taxes in a timely manner and what they should pay if they fully complied with the tax laws — is hundreds of billions of dollars annually, significantly depriving the nation of much-needed revenue. This paper explores the mixed effects of technological advancements on tax compliance — and, thus, its counterpart, tax noncompliance. On the one hand, technological advances have largely eradicated many of the commonplace tax-noncompliance techniques that once reigned during the twentieth century. On the other hand, many of these very same technological advances threaten to usher in new modes of tax evasion. Which of these emergent trends will dominate is unclear. The outcome will largely depend upon whether Congress updates the tax laws to address technological advances and grants sufficient funding to the Internal Revenue Service to maintain robust enforcement efforts in an ever-changing technological landscape. Failure to take these steps will destine the size of the tax gap to expand. Many prior studies have addressed discreet effects of specific technologies on tax compliance. This paper contributes to this developing literature by offering a cohesive framework to address technological advancement and tax compliance. Keywords: Technology, tax compliance, tax gap. JEL-Classification: H24, H26. I. INTRODUCTION Since the introduction of the nation’s modern income tax in 1913,1 tax noncompliance has been a persistent concern.2 Evidence for this proposition abounds. Court adjudications in which taxpayers have sought to shortchange the government could fill tomes;3 the Internal Revenue Service (Service) customarily dedicates a large proportion of its annual budget to help ensure taxpayer compliance;4 and Congress * James Alm is an economics professor in the Department of Economics at Tulane University; Joyce Beebe is a fellow in public finance at Rice University’s Baker Institute for Public Policy; Michael S. Kirsch is a law professor at Notre Dame Law School; Omri Marian is a law professor and the academic director of the Graduate Tax Program at the University of California, Irvine School of Law; and Jay A. Soled is a tax professor in the Rutgers Business School at Rutgers University. All five authors have written and lectured about ways to close the tax gap. 1 See Revenue Act of 1913, ch. 16, 38 Stat. 114. 2 Tax noncompliance (or tax evasion) should be distinguished from tax avoidance. Avoidance represents activities by which taxpayers legitimately and legally reduce their tax burden. Evasion occurs when taxpayers purposefully do not pay what the Code instructs is their appropriate and legally due tax burden. See PAUL WEBLEY, HENRY ROBBEN, HENK ELFFERS & DICK HESSING, TAX EVASION: AN EXPERIMENTAL APPROACH 2 (J. Richard Eiser & Klaus R. Scherer eds., 1991); see also Bullen v. Wisconsin, 240 U.S. 625, 630–31 (1916) (“[W]hen the law draws a line, a case is on one side of it or the other, and if on the safe side is none the worse legally that a party has availed himself to the full of what the law permits [referring to tax avoidance]. When an act is condemned as an evasion, what is meant is that it is on the wrong side of the line indicated by the policy if not by the mere letter of the law.”). 3 For a sampling of such adjudications, see Steven R. Toscher, Dennis L. Perez, Charles P. Rettig & Edward M. Robbins Jr., Tax Crimes, U.S. INCOME PORTFOLIOS (BNA) No. 636 (2019). We do not claim that this list is exhaustive. 4 See INTERNAL REVENUE SERV., PUB. 55-B, DATA BOOK, 2018, at 65 tbl.28 (2019), https://www.irs.gov/pub/irs- pdf/p55b.pdf (indicating that the IRS dedicates around 40 percent of its budget to enforcement activities). 1 regularly enacts reform measures designed to curtail derelict taxpayer behavior, such as expanded third- party information returns,5 disclosure statements,6 and the imposition of penalties.7 Numbers confirm this narrative. The Service periodically estimates the size of the “tax gap” — the difference between what taxpayers pay to the U.S. government and what they would owe if they were fully compliant with the tax laws — and these estimates indicate a large, persistent, and growing problem, one whose magnitude is a major contributor to the country’s revenue shortfall. Over time, and in absolute dollar amounts, the tax gap has grown. The first Service estimate of the tax gap occurred in 1973 and indicated a tax gap of about $28 billion with an associated “voluntary compliance rate” (VCR), defined as taxes paid relative to total taxes legally due, of about 84 percent.8 Subsequent estimates throughout the 1970s and 1980s showed a steady growth in the tax gap with a fairly constant VCR of roughly 81–83 percent.9 By the time the Service released updated estimates for 1992 for the individual income tax, the gross tax gap had increased to over $93 billion.10 Most recently, the Service estimated the gross tax gap to be $441 billion annually (for tax years 2011–2013) with an associated VCR of 83.6 percent.11 Eliminating this gap would have come close to abolishing the nation’s annual budget deficit, at least before the recent explosion in the budget deficit following the enactment of the Tax Cuts and Jobs Act of 2017.12 Over the course of the past half-century, the nature of tax compliance and its counterpart tax noncompliance (or tax evasion) has changed. In this paper, we examine the past, present, and potential future trajectory of tax compliance. While many researchers have addressed specific technological advancements and their effects on tax compliance, this paper is the first to offer a cohesive framework to discuss this important issue. Part II examines the underpinnings of tax noncompliance and illustrates several of the twentieth century’s most prominent tax-noncompliance techniques. Parts III and IV discuss, respectively, the likely effects that technological changes will have on the government’s efforts to reduce tax noncompliance and taxpayers’ ability to circumvent those efforts. Part V concludes. II. FUNDAMENTALS OF TAX NONCOMPLIANCE Tax-noncompliance techniques often reflect the cultural and societal landscapes of the times. By way of example, consider the plight of taxpayers in ancient Egypt, which was then a largely agrarian society. 5 See, e.g., I.R.C. § 6045(g) (requiring brokers to track and report the tax basis that taxpayers have in their marketable securities). 6 See, e.g., id. § 6707A(c)(1) (delineating what constitutes a so-called reportable transaction). 7 See, e.g., id. § 6662(i) (applying a higher penalty for those transactions lacking economic substance). 8 See Internal Revenue Serv., Pub. 7285, Income Tax Compliance Research: Gross Tax Gap Estimates and Projections for 1973–1992 (1988), https://www.irs.gov/ pub/irs-soi/p7285388.pdf. 9 See Internal Revenue Serv., Pub. 1415, Federal Tax Compliance Research: Individual Income Tax Gap Estimates for 1985, 1988, and 1992, at 5, 6 (rev. Apr. 1996), https://www.irs.gov/pub/irs-soi/p141596.pdf; Jonathan Skinner & Joel Slemrod, An Economic Perspective on Tax Evasion, 38 Nat’l Tax J. 345, 345 (1985) (estimating a $90 billion tax gap for 1981). 10 See INTERNAL REVENUE SERV., supra note 9, at v. 11 See INTERNAL REVENUE SERV., PUB. 5364, TAX GAP ESTIMATES FOR TAX YEARS 2011–2013, at 1 (Sept. 2019), https://www.irs.gov/pub/irs-pdf/p5364.pdf. For earlier years’ estimates, see The Tax Gap, IRS (last updated Dec. 5, 2019), https://www.irs.gov/uac/the-tax-gap; I.R.S. News Release IR-2012-4 (Jan. 6, 2012). 12 See CONG. BUDGET OFFICE, THE BUDGET AND ECONOMIC OUTLOOK: 2016 TO 2026, at 144, summary tbl.1 (Jan. 2016), https://www.cbo.gov/publication/51129 (indicating that the fiscal year (FY) 2015 deficit for the federal government was $439 billion and rose to $544 billion in FY 2016 and projecting that the deficit will increase over the next decade).