Income Tax Fraud: Estimations of Its Dimensions; Its Economic Consequences and a Tax Reform Proposal

Abstract

Despite considerable improvements in public finance since 2001, the GDP ratio of the budget and public deficits are expected, respectively, to be around 2% and 6% in 2011. Apparently there is no room left for further reductions in any of the main items of public expenditures. So, to further reduce the public deficit, Turkey must increase its public revenues the GDP ratio of which is less than half of that of the EU and the OECD average. The problem lies in the dearth of direct tax revenues and of personal income tax receipts which nowadays stand at 0.047GDP of which 91.7% is paid by wage and salary recipients. All the rest of the recipients of taxable personal income (BTGVM) declare their before tax income is 2% of the GDP and end up paying the ludicrous sum of 0.035% of the GDP in personal income taxes. This implies that these persons actually earn, not 2% but 26%-30% of the GDP. Using detailed statistics released by the Finance Ministry, tabulating the average earnings reported and the income taxes paid by 46 groups of tax-payers categorized by “field of activity” and the average income tax-rate incurred by each category, the authors first make micro based analyses and then approach the same issue using National Income accounts. In both cases they reach similar results: that this class of citizens are fraudulently reporting only 1/13th to 1/15th of their before tax income and that the earned but unreported income in Turkey is no less than 0.3GDP when unreported corporate profits are also included. These estimations by the authors are confirmed by the fact that, the National Income Accounts was recently “corrected” officially, by the creation a new GDP series that added 30%-33% to the old series. There is another sour-spot in the tax system: The de-jure personal income tax schedule direly need an overhaul because it starts by taxing the minimum wage income and less at a whopping 15% and it swiftly shoots up to the marginal rate of 35% at a very low level of pre-tax income of only 28,000 USD per year which happens to be the maximum marginal rate applied to even multi-millionaires. The authors suggest that, if a much more progressive de-jure income tax schedule which starts with 0 or 1% rate for incomes below the minimum wage (5,000 USD), which reaches the present maximum of 35% marginal rate at about 70,000 USD (instead of the present 28,000) and which rises to about 60% for the highest income-levels and if simultaneously the necessary judicial and institutional measures were taken to effectively minimize the colossal size of “earned but unreported and hence untaxed incomes”, then Turkey would be able to increase its direct-income tax revenues (cet.par.) by no less than 10%-12% of GDP. The authors then argue that if both were accomplished, not only the public deficits would be cet.par., minimized, reducing inflation and interest rates as well as the domestic savings gap (thus enhancing economic stability) but also Turkey would increase her public