Tax evasion is the deliberate attempt by an organization or individual to circumvent paying their due share of taxes. Tax evasion often associated with the high class and organizations is gaining popularity in the US. The tax gap (The difference between taxes owed and taxes filed on time) has steadily increased in the past decade, The IRS reports that for the years 2014-2016 the tax gap increased $496 billion, a rise of over $58 billion from the prior estimates. This cost the US government billions of dollars each year. The majority of the tax gap is from individual tax payers although some of it is eventually paid majority are not filed. Most of these unpaid taxes result from taxpayers reporting less than they earned. Generally individuals tend to avoid taxes while companies avoid it, meaning companies do not pay their fair share of taxes but do it legally.
Methods used in tax evasion
1.Tax havens
Most of the tax evasion in the developed world is carried out by wealthy individuals who have a higher tax bracket and is financially better for them to avoid paying taxes, because tax evasion can a complex and expensive process.
One popular method is using a tax haven country. A tax haven is a country which has extremely low tax rates for both citizens and foreign individuals. Tax havens are also infamous for non compliance with foreign tax authorities making them the perfect place to stash one’s wealth. The pandora papers released in October 2021 unveiled massive offshore tax havens for politicians and organizations in the Caribbean and panama.
Some of the most prolific tax havens are:
- Luxembourg
- Cayman Islands
- Ireland
- Switzerland
- Bermuda
- Hong Kong
- Jersey (A British dependency located in the English channel)
- Netherlands
- Singapore
- British Virgin Islands
Most of these countries and territories have strong financial secrecy laws that obscure the true amount of wealth hidden. Wealthy individuals use Shell companies that exist only on paper and have no operations in real life to secure their assets. The assets are owned by the company on paper and not taxed.
2. Multiple Layering
Multiple Layering refers to moving assets through multiple jurisdictions each with their own rules and secrecy laws, This makes the assets impossible to track and tax. Layering is commonly used to launder illegally obtained assets.
3.Trust and Foundations
These are legal entities separate from the individual who originally owned the assets. The trust holds and manages the assets for the beneficiary ensuring protection from the legal entities.
Some forms of Trusts i.e irrevocable trust can help reduce estate taxes, furthermore tax evaders use these trusts to depreciate the value of assets such as homes and vehicles reducing their tax bracket.
The main selling points of trusts is that they give the appearance of a person giving up their assets while in reality they still hold and control their assets.
Informal economies
The informal economy is the part of the economy that is not taxed or regulated by the government and is not recorded in the countries’s GDP . Informal economies make up a significant portion of the economy in developing countries providing employment to large portions of the population.
In the US illegal activities such as drug trafficking and prostitution make up the informal economy and generate billions of dollars each year. The US has taken initiatives to tax these incomes, 17 US states have a ‘controlled substances’ tax that is paid if you are caught in possession of such substances.
Some tax evaders use these sectors of the economy to hide their wealth, i.e a wealthy person from a developed country might go to a developing country and set up shadow businesses in another name that generate profits on paper but are only used to hide their owner’s wealth.
How billionaires legally avoid paying taxes
Most of the official tax gap originates from individual tax payers but that is only because illegal tax avoidance attempts are recorded, organizations and billionaires use legal moves to avoid paying their fair share of taxes.
This illustration shows a stark contrast in the tax gap between the wealthy class and the lower classes.
The world of tax evasion is exclusive and hard to get in for ordinary folks, usually for salary men it is not worth it to engage in tax avoidance or evasion as the risks and costs far outweigh the benefits but for wealthier individuals and organizations it is financially beneficial to avoid paying taxes. Although the methods used by these wealthy individuals are available to everyone the process to apply them is often complex and expensive, shutting out the lower classes. As such efforts to evade income tax decline when the amounts are lower.
Some of the methods employed by the ultra rich is to take out loans from banks and use that as cash while keeping their stock as collateral, since loans are not taxed they won’t have to pay any taxes. Jeff bezos for example make around $8 millions dollars per hour, this is the increase in the Amazon shares he owns, but he pays little in taxes by leveraging his stocks to take out loans. His shares can only be taxed if he sells them so he never does.
Another method used by billionaires to avoid paying taxes is Charity. Billionaires set up private charitable foundations, every time they donate to their own organization they get an immediate tax deduction, the organization then spend a small amount of their assets usually 5% as required by US law. Jeff bezos owns the “Bezos family foundation” while Bill gates owns the Bill & Melinda Gates Foundation. This method is legal but is seen as highly unethical.
If you are in a higher tax bracket you wouldn’t want a high salary that would only increase the taxes you pay, instead take stock options as payment or real estate. Capital gains are taxed at a lower rate usually 15% compared to ordinary income which can be taxed up-to 37%, so billionaires avoid cash altogether.
Impact of tax evasion
- Erosion of public trust: To counteract the loses from tax evasion governments increase the tax rates hurting the populous. This in turn erodes the public’s trust in the government leading to dissatisfaction and dissent. The french king Louis XVI was overthrown and executed by his own people as a result of aggressive tax farming and corruption.
- Market distortion: Companies not paying their due share of taxes creates unfair advantages in their favor distorting the free market and creating monopolies. This causes an unnatural growth of these companies where they contribute little to the economy but have large assets.
- Revenue Loss: The US economy loses hundred’s of billions of dollars annually to tax evasion and avoidance. This results in poor social services and lack of funds for infrastructure and Vital services.
- Puts pressure on honest taxpayers: Tax dodgers force the government to increase taxes to compensate for the lost revenue. This in turn creates more tax dodgers fueling a cycle of tax increases.
Overall tax evasion is a complex and risky process carried out by individuals with much to gain from it, Many justify their crime by claiming that the exchange between their taxes and the services provided by the government is unequal therefore they shouldn’t pay. Whatever the excuse tax evasion hurts the economy and creates and unfair situation where one group pays their taxes and the other doesn’t.
Governments all over the world are coming up with ways to combat tax evasion and ensure financial accountability for all. Many Governments in recent times have agreed to limit financial secrecy laws to combat offshore havens.
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