Bryan Caplan  

Is Tax Evasion a Good Investment?

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Gary Becker strongly suggests that it is:

If taxpayers responded only to the expected cost of evading taxes, evasion would be far more widespread. The reason is that only about 7 percent of all tax returns are audited (over a 7 year period), and typically the penalty on under reported income is only about 20 percent of the taxes owed. Virtually no one is sent to jail simply for evading taxes unless that evasion is on a very large scale, or involves massive fraud. If a person were to evade $1,000 in taxes, his expected gain would be 0.93x$1000 -0.07x$200 (=$1000/5) = $916. On these considerations alone, he should not hesitate to evade paying the $1,000, and presumably much more.

To be sure, the expected gain is not the right criterion since most taxpayers would be risk averse regarding audits and punishments, especially if there is some chance of much greater than the average punishment or likelihood of an audit. However, if the expected gain from evading $1,000 were $916, the degree of risk aversion would have to be huge, far higher than the risk aversion that is embodied in pricing of assets, for risk to explain why there is so little tax evasion.

Could the explanation be most people underestimate the return to tax evasion, because the IRS persecutes anyone who tries to raise the public's awareness?

I hope not!


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COMMENTS (11 to date)
John Thacker writes:

There are taxes that are widely evaded-- perhaps most notably, the states that have a "please put here how much you bought from catalogs and the Internet and didn't pay state taxes on, and pay appropriate taxes on" box.

I suspect that it's related to why so many people bother voting, no?

Most people earn income that is reported on 1099s, W2s, K-1s, etc that are coded with their federal I.D. #. When the recipient files a return, or fails to file one, a computer matches up the income. The computer spits out a form and the assessment is collected agains future income taxes. Its very difficult to evade taxes that are subject to that system.

As John Thacker mentioned, there is no comparable information exhange for use taxes and they are widely evaded. Similarly, expenses, charitable contributions and basis are overstated, certain mortgage deduction limitations are widely ignored, and unreported income left off at a fairly routine pace. People who can, do evade spiritedly.

Maniakes writes:

The way for people with documented income to evade taxes is to claim false deductions.

Becker underestimates the cost -- the IRS uses heuristics to identify returns to audit that are likely to contain substantial evasion, so your odds are higher than 7% if you're evading a significant amount of taxes. The 20% figure is an average which contains many people who don't have significant assets for the IRS to attach; a random middle class person who decides to evade as an investment would risk having his house seized and auctioned off to cover the tax liability. It's also 20% of taxes owed, which is not the amount evaded, but rather the amount evaded plus interest and penalties. And there's a cap of about $40,000 (I think someone mentioned this on Volokh Conspiracy when they were discussing Barry Bonds not being pursued for tax evasion) past which the Feds are likely to pursue felony charges.

Nathan Benedict writes:

I frequent a poker message board. Playing poker for a living is one of the few jobs where the IRS really has no independent info about how much money you've made. Nonetheless, the vast majority of posters seem absolutely terrified of the possibility of an audit and even prison time should they ever understate their income. (And these are people who do expected-value calculations for a living!) Perhaps they're just posturing on-line in case the IRS is snooping, while privately cheating, but I doubt it. There's a palpable feeling that the IRS is much bigger, more aggressive, and more competent than it actually is. I suspect this reputation is the largest factor in keeping tax evasion relatively low among those with the opportunity to cheat. Most people, of course, have no such opportunity due to wage reporting on W-2's etc.

Floccina writes:

People are excessively risk averse.

Jack writes:

William Schulze and co-authors had a paper (1992?) in J Public Economics on this topic, essentially asking: Why do people pay taxes? I think the conclusion is about the same: it would take a lot of risk aversion to make the empirical results consistent

Heather writes:

I think the problem is that the risk of an audit is understated in the scenario he paints. If you are engaging in certain activities or claiming certain types of exemptions, your risk of an audit increases significantly because you are "flagged" as a likely tax evader. Small business owners are more likely to be audited as are people with high medical expenses they write off. I would suspect someone who plays poker professionally is also in this category and is rightly paranoid.

jaim klein writes:

I worked with an American lawyer who systematically made "technical" mistakes adding one number like 1000 instead of 100 and viceversa 1111 instead of 111. As far as I know, he did get away with it. I wouldnt dare to do it.

Ashley writes:

In my opinion, the risk is not necessarily the issue here. It is more of a moral issue. It is not fair if only a few people pay for the roads, schools, policemen, hospitals, etc. Maybe I am naive, but I do not think there is a big enough percentage of individuals that knowingly commit tax evasion . For myself, tax evasion would just weigh on my conscious entirely too much. I would not want something like that lurking over my shoulder. I think most other Americans would feel the same. With that said, I only see people who are in a really tight spot as the ones who do not pay their taxes.

Matt writes:

Te real problem we suffer, almost he core problem with our economic drift, is that middle aged, 45 to 55 year old employees are better off taking their capital gains, then quit working for 10 years, until the statute runs out. The reason is the demographic bias against middle aged workers in social security.

When I have to buy or sell property, for example, I skip the agents and deal directly, and invariably it is buying and selling in the child's name by the father, who has gone underground.

This underground economy among the middle aged is probably much larger than we previously thought, people who already refuse to participate.

AB writes:

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