The annual tax gap (the difference between the amount of tax collected and the amount legally owed) is estimated to be at least $400 – $600 billion a year, depending on the year and who is making the estimate. The rich are often blamed, either for evading taxes or for not paying their “fair share,” whatever that is. The facts, however, reveal a different story. The top one percent have an average tax rate of about 26 percent, compared to about 3 percent for the bottom half. The top one percent pay about 42 percent of total federal income taxes, compared to 2.3 percent for the bottom half of all taxpayers. Thus, it would appear that the rich actually pay much more than their fair share and are entitled to a tax break, an argument that is almost never made by a politician. Elon Musk reportedly paid about $11 billion in taxes one year, which is more than the GDP of some countries, but that isn’t enough to satisfy some politicians and pundits.
One possible solution to close the tax gap that has been floated around is to hire 87,000 additional IRS agents, supposedly to squeeze more taxes out of the rich. The problem with that proposal, aside from the fact that the rich are already paying more than their fair share, is that nowhere near 87,000 new IRS agents are needed to further fleece the few really rich people in this country. What is more likely is that they will be unleashed against the middle class, which is where most of the money is.
Rather than narrow the tax gap by hiring more “tax police” (the term used in Russia), a better approach would be to eliminate the reasons why people evade taxes. Once the causes of tax evasion have been identified, it might be possible to find ways to reduce the extent of evasion.
Why People Evade Taxes
There is no need to conduct studies to identify the reasons why people evade taxes. Fortunately, those studies have already been done. Here are the top 10 reasons that have popped up in the literature.
1) The government is tyrannical. Tyranny can come in many forms. The Judenvermögensabgabe (“Jewish Capital Levy”) that forced Jews (or anyone) to pay taxes to Hitler is one of the more egregious examples given in the literature. Other forms of tyranny might include persecuting or harassing people because of their religious or political beliefs, imprisoning political opponents, confiscating private property, conducting searches without a warrant, punishing people for engaging in peaceful protests or for engaging in victimless crimes, etc. People would be more willing to pay taxes if the level of tyranny were reduced (or preferably eliminated).
2) Tax rates are too high. During the 1950s, the top marginal tax rate was more than 90 percent. Such a high tax rate not only discouraged productive economic activity, but also strongly encouraged tax evasion. Although tax rates are no longer that high, they are still sufficiently high to entice some taxpayers to evade taxes, especially if they feel they are being exploited by government. An excessively high tax rate was one of the top reasons why people justified tax evasion in many surveys.
3) The tax system is unfair. The perception that the tax system is unfair was one of the common justifications of tax evasion in many studies. and also frequently cited in the religious literature. The obvious solution to reduce tax evasion in this case would be to make the tax system fairer. The problem, however, is that it is difficult to reach consensus on what the attributes of a fair tax system might be.
4) Inability to pay. Inability to pay was one of the strongest arguments to justify tax evasion in the historical literature, and it also in recent surveys. To partially alleviate this problem, we could reduce tax rates. Another option would be to exempt income earned below a certain threshold, which is already part of the existing tax system.
5) Tax funds are wasted. There is a widespread perception that the government wastes a lot of money. Anyone who has been in the military or who has worked for government has probably witnessed massive waste firsthand. Examples include the purchase of $400 hammers, billion-dollar websites that don’t work, and bridges to nowhere. Fewer taxpayers would feel justified in evading taxes if such news of massive government waste were rare, rather than the norm.
6) Tax funds are spent on immoral projects. One way to reduce this justification for tax evasion would be to reduce or eliminate funding for projects that are considered morally reprehensible to a large segment of citizens. Taxpayer funding of abortion is one such target for defunding, but it is not the only one. Public money for what some people refer to as “gender affirming care,” is another example that dubious taxpayers might resist funding.
7) Tax funds are spent to support unjust wars. Some people protested US involvement in the Vietnam War by filing tax returns that claimed an inflated number of dependents, which reduced their tax liability to zero. They were not able to get away with this ploy, however. The IRS fined them and made them pay the correct amount of taxes, but they were able to voice their protest symbolically. Invading countries that pose no threat to the United States could be given as more modern examples, but they are not the only ones. This justification might be extended to wars and military actions that US taxpayers are forced to support, even if they are considered just wars, such as the war between Russia and Ukraine and the war between Israel and the Palestinian people, some of whom support Hamas. It might also be pointed out that American tax dollars have been used to fund both sides of the Israeli-Palestinian conflict. In addition to giving billions of dollars in military and other aid to Israel, the US government gave millions to Hamas to help the Palestinian refugees. Whether the funds were actually spent on refugees is difficult to determine, since the spending was never supervised. The fact that Congress has, as of this writing, refused to allow an audit to determine how the funds given to Ukraine have been used, raises red flags about how the funds might be misspent. One thing we do know is that US taxpayer funds were used to pay Ukrainian bureaucrats’ salaries and pensions.
8) People pay for benefits they do not receive. Much federal spending does not benefit the people who fund the projects. Many, perhaps most, federal projects might be considered special interest projects because they fund a small minority of people at the expense of the general public. Taxpayers who live in Missouri and Arizona are not inclined to fund the building of a bridge in West Virginia, for example. Federal subsidies to the public transportation systems in New York City or Los Angeles are funded by taxpayers who live hundreds or thousands of miles away. Funds spent on any foreign aid project would also fall into this category.
9) Tax payments are pocketed by corrupt politicians, their families or friends. Using taxpayer funds to pay excessive legal fees to a boyfriend, or funneling federal contracts to friends and family are some examples of the kind of government abuse that justifies tax evasion in the minds of some taxpayers.
10) Taxes support governmental institutions in which the people have lost trust. Several studies have found that there is a correlation between confidence in government, the police, the civil service or the justice system and willingness to pay taxes. The less confidence they have in these institutions, the fewer qualms they have about evading taxes.
The obvious conclusion to be drawn from these studies is that tax evasion could be reduced if people had more confidence in their government and in governmental institutions.
It is possible to reduce tax evasion without sending armed IRS agents to kick in doors or confiscate assets. The ten reasons given above provide some guidance to creating a tax system most people would voluntarily support. If implemented, these would not only reduce tax evasion but would result in a more just society.