Unreported Income Research Articles

Measuring Income Tax Evasion Using Bank Credit: Evidence from Greece *

AbstractWe document that in semiformal economies, banks lend to tax-evading individuals based on the bank’s assessment of the individual’s true income. This observation leads to a novel approach to estimate tax evasion. We use microdata on household credit from a Greek bank and replicate the bank underwriting model to infer the banks estimate of individuals’ true income. We estimate that 43–45% of self-employed income goes unreported and thus untaxed. For 2009, this implies €28.2 billion of unreported income, implying forgone tax revenues of over €11 billion or 30% of the deficit. Our method innovation allows for estimating the industry distribution of tax evasion in settings where uncovering the incidence of hidden cash transactions is difficult using other methods. Primary tax-evading industries are professional services—medicine, law, engineering, education, and media. We conclude with evidence that contemplates the importance of institutions, paper trail, and political willpower for the persistence of tax evasion.

Identification of Households Prone to Income Underreporting

Pissarides and Weber propose using data on income and food consumption for estimating the extent of income underreporting by the self-employed, a group seen to be prone to income underreporting. This paper is the first to investigate the importance of the way in which these households are identified in such analyses. Using household budget data from Estonia, different ways are used to identify households prone to income underreporting and to estimate the extent of the underreporting. The share of unreported income is estimated to be substantially larger when underreporting households are identified using their share of reported business income than when they are identified using their employment status. Further analysis combines the different identification methods and reveals that the employment status provides no information on underreporting when the share of business income is taken into account. The share of reported business income is the most informative indicator of underreporting.

Three Principles to REVISE People’s Unethical Behavior

Dishonesty and unethical behavior are widespread in the public and private sectors and cause immense annual losses. For instance, estimates of U.S. annual losses indicate $1 trillion paid in bribes, $270 billion lost due to unreported income, and $42 billion lost in retail due to shoplifting and employee theft. In this article, we draw on insights from the growing fields of moral psychology and behavioral ethics to present a three-principle framework we call REVISE. This framework classifies forces that affect dishonesty into three main categories and then redirects those forces to encourage moral behavior. The first principle, reminding, emphasizes the effectiveness of subtle cues that increase the salience of morality and decrease people’s ability to justify dishonesty. The second principle, visibility, aims to restrict anonymity, prompt peer monitoring, and elicit responsible norms. The third principle, self-engagement, increases people’s motivation to maintain a positive self-perception as a moral person and helps bridge the gap between moral values and actual behavior. The REVISE framework can guide the design of policy interventions to defeat dishonesty.

Public and private sector jobs, unreported income and consumption gap in India: Evidence from micro-data

This paper documents the wage and consumption gap between private and public sector employees in India. We empirically investigate the wage gap as well as difference in consumption expenditure using household survey from the 2004-05 National Sample Survey of India. Our results show that despite a lower level of public sector income in some of the income quantiles, the consumption of durable goods is not different between these two groups, statistically. After checking for competing explanations, we conclude that the absence of statistically significant consumption gap could be an outcome of ‘unreported’ income earned by public sector workers in India.

The shadow economy as an equilibrium outcome

We construct a dynamic general equilibrium model of tax evasion where agents choose to report some of their income. Unreported income requires using a payment method that avoids recordkeeping in some markets—cash. Trade using cash to avoid taxes is the ‘shadow economy’ in our model. We then calibrate our model using money, interest rate and GDP data to back out the size of the shadow economy for a sample of countries and compare our measures to traditional reduced form estimates.

Determinants of aggregate income-tax-evasion behaviour: the case of US

The determinants of aggregate income-tax-evasion behaviour as reflected in the size of the underground economy in the US are analysed. These factors include the federal personal income tax rate, the social security tax rate, the federal corporation income tax rate, the public's dissatisfaction with the government, IRS audit rates and IRS penalty assessments on detected unreported income. The results show that the size of the underground economy is an increasing function of federal personal income tax rate, the social security tax rate and the public's dissatisfaction with the government. However, the size is a decreasing function of IRS penalty payments on unpaid taxes. JEL Codes: H26, E26 Keywords: Research, Underground economy, tax evasion, US economy

Corruption Measurement: The Case of Russian Federation

This study develops the approach of corruption measurement based on the incomeexpenditure comparison. Using micro-level data on reported household earnings, expenditures and assets provided by Russian Longitudinal Monitoring Survey for the period 2000-2009 we nd that households with workers in the public sector receive lower earnings than their private sector counterparts, but enjoy the same level of consumption expenditures, in other words there exists an expenditure-income gap in favor of the public sector. Controlling for the reported level of earnings, households with workers in the private sector do not show neither a signicantly higher probability of possessing country houses, cars and computers, nor living in better housing conditions, nor having higher nancial wealth. The analysis of current and accumulated savings, risk aversion and volatility of wages does not show any sign of distinction between two sectors. Thus, dierences in assets and precautionary motives of workers cannot reconcile the sizeable expenditureincome gap. Unexplained dierences are referred to unreported income, or bribes.

Measuring the Shadow Economy: Endogenous Switching Regression with Unobserved Separation

We develop an estimator of unreported income that relies on much more flexible identifying assumptions than those underlying previous estimators of the shadow economy using household-level data. Assuming only that evading households have a higher consumption-income gap than non-evaders in surveys, an endogenous switching model with unknown sample separation enables the estimation of both the probability of hiding income and the expected amount of unreported income for each household. Using data from Czech and Slovak household budget surveys, we find the size of the shadow economy to be substantially larger than estimated using other techniques. These results are robust under a number of alternative specifications.

Social programs as positive inducements for tax participation

A significant amount of non-compliance with the personal income tax is due to individuals who have not filed a tax return and so who are not “in the system”. We use experimental laboratory methods to examine the effect of positive inducements for filing a tax return. Our design captures the essential features of a voluntary income reporting and tax assessment system: human participants earn income, they must decide whether to file a tax return, and, conditional upon filing, they must choose how much income to report. Taxes are paid on reported income only. Unreported income of filers may be discovered via a random audit, and the participant then pays owed taxes plus a fine. Inducements for filing are introduced as treatments: a social safety net (e.g., unemployment replacement income) that is conditional upon past filing behavior, and a tax credit that is available only to those who file. Our results suggest that an untargeted tax credit can encourage participation, but that targeting the credit to low income earners offers a stronger inducement to file. Also, the provision of a social safety net via unemployment benefits has a positive, albeit an indirect, impact on participation.

Tax Liability for Wage Theft

This paper shows how, under existing tax law, illegal wage underpayment by an employer (sometimes called “wage theft”) may generate employer tax liability for unreported income or disallowed business expense deductions. Given that the tax authority needs information from the underpaid worker to prove such liability, the paper identifies two ways that a worker can transmit that information to a tax authority: becoming a tax informant, or bringing a qui tam action under a state false claims act. Finally, the paper discusses possible influences on the decision of the unpaid worker to inform on the employer to the tax authority, and considers the conditions under which a tax authority is likely to audit an employer based on such information. In so doing, the paper identifies a new approach to combating wage theft and an undiscovered implication of basic income tax law.

Public and Private Sector Jobs, Unreported Income and Consumption Gap in India: Evidence from Micro-Data

This paper tries to document the presence of unreported income among public sector employees in India. We investigate empirically the wage gap as well as consumption expenditure parity between public and private sector workers. It tests the hypothesis that despite a lower level of public sector income in some of the quantiles, if the level of durable goods consumption between the private and the public sector employees are similar, then it might be indicative of the presence of unreported income among the public sector workers. The 2004-05 survey of income and consumption by workers in both private and public sectors (NSSO) supports presence of unaccounted for income among public sector employees at the uppermost quantile. The empirical part is followed by a generalized theoretical formulation that comes up with a measure of the equilibrium level of the unreported income earned by the public sector employees.

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

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

Impact assessment of alternative reforms of Child Allowances using RUSMOD –the static tax-benefit microsimulation model for Russia

RUSMOD is a static tax-benefit microsimulation model for Russia. The model can be used for ex post and ex ante evaluation of reforms of personal income taxation and social benefits in Russia. In addition, being compatible with EUROMOD, the Russian model is suitable for simulation of cross-country policy transfers. The aim of this paper is to shed light on various aspects of the model. It discusses specific problems arising in the evaluation of unreported income and benefits non-take up in Russia. The final estimates of poverty and inequality from RUSMOD are very close to those based on National accounts; hence, the model can be seen as a reliable tool for evaluating the current performance of the Russian tax-benefit system and the distributive impact of potential tax-benefit reforms. Then the paper provides an example of application of the model - an analysis of alternative scenarios for improving the design of child allowances in Russia. Currently, this benefit has a poor targeting performance and varies across regions of Russia in terms of design and generosity, which raises serious equity concerns. Redirecting these resources to the poor - by means of better targeting and raising the benefit amounts - brings about significant improvements in overall and child poverty indicators even at the current level of spending. The most sizable impact on poverty is achieved by implementing the unified national design of the program.

Tax Evasion Across Industries: Bank Evidence from Greece

We use bank microdata on household credit to document the magnitude and incidence of tax evasion for Greece. We start from the new observation that in many developed and emerging countries, banks lend to tax-evading individuals based on the bank’s perception of true income. This insight leads to a novel approach to estimate tax evasion from private-sector adaptation to a norm of semiformality. The paper has two main contributions. Replicating the bank’s credit scoring of hard and soft information, we estimate a lower bound of 27 billion euros of unreported income for Greece. Our best estimate is that tax evasion is 41 billion euros. The foregone government revenues amount to 68 percent of the deficit for 2010. The second contribution is analyzing the industry distribution of tax evasion. Primary tax-evading occupations are lawyers, dentists, doctors, financial services, accountants, and other professional services. The industry distribution of tax evasion is not consistent with the theory that governments would want to subsidize the apprentice training of low-skilled workers. Instead, the industry distribution is consistent with a role for paper trails in hindering tax evasion for some industries and with politicians protecting their own occupations. We conclude by commenting on the property right of informal income and with suggestions for a business license fee to collect needed tax revenues.

Measuring the Shadow Economy: Endogenous Switching Regression with Unobserved Separation

We develop an estimator of unreported income, perhaps due to tax evasion, that does not depend on as strict identifying assumptions as previous estimators based on microeconomic data. The standard identifying assumption that the self-employed underreport income whereas wage and salary workers do not is likely to fail in countries where employees are often paid under the table or engage in corrupt activities. Assuming that evading individuals have a higher consumption-income gap than non-evading ones due underreporting both to tax authorities and in surveys, an endogenous switching model with unknown sample separation enables the estimation of consumption-income gaps for both underreporting and truthful households. This avoids the need to identify non-evading and evading groups ex-ante. This methodology is applied to data from Czech and Slovak household budget surveys and shows that estimated evasion is substantially higher than found using previous methodologies.

America’s unreported economy: measuring the size, growth and determinants of income tax evasion in the U.S.

This study empirically investigates the extent of noncompliance with the tax code and examines the determinants of federal income tax evasion in the U.S. Employing a refined version of Feige’s (Staff Papers, International Monetary Fund 33(4):768–881, 1986, 1989) General Currency Ratio (GCR) model to estimate a time series of unreported income as our measure of tax evasion, we find that 18–23% of total reportable income may not properly be reported to the IRS. This gives rise to a 2009 “tax gap” in the range of $390–$540 billion. As regards the determinants of tax noncompliance, we find that federal income tax evasion is an increasing function of the average effective federal income tax rate, the unemployment rate, the nominal interest rate, and per capita real GDP, and a decreasing function of the IRS audit rate. Despite important refinements of the traditional currency ratio approach for estimating the aggregate size and growth of unreported economies, we conclude that the sensitivity of the results to different benchmarks, imperfect data sources and alternative specifying assumptions precludes obtaining results of sufficient accuracy and reliability to serve as effective policy guides.

New estimates of U.S. currency abroad, the domestic money supply and the unreported economy

Despite financial innovations that have created important new substitutes for cash usage, per capita holdings of U.S. currency amount to $2950. Yet American households and businesses admit to holding only 15% of the currency stock, leaving the whereabouts of 85% unknown. Some fraction of this unaccounted for currency is held abroad (the dollarization hypothesis) and some is held domestically undeclared, as a store of value and a medium of exchange for transactions involving the production and distribution of illegal goods and services, and for transactions earning income that is not reported to the IRS (the unreported economy hypothesis). We find that the percentage of U.S. currency currently held overseas is between 30 and 37% rather than the widely cited figure of 65%. This finding is based on the official Federal Reserve/Bureau of Economic Analysis data which is a proxy measure of the New York Federal Reserve’s (NYB) “confidential” data on wholesale currency shipments abroad. We recommend that the NYB data be aggregated so as to circumvent confidentiality concerns, and be made readily available to all researchers in order to shed greater light on the questions of how much U.S. currency is abroad and on the particular location of overseas U.S. dollars. The newly revised official estimates of overseas currency holdings are employed to determine the Federal Reserve’s seigniorage earnings from 1964–2010, which have provided a $287 billion windfall for U.S. taxpayers. Overseas currency stock data are also used to derive estimates of the domestically held stock of currency as well as narrow and broad measures of domestic monetary aggregates. These domestic monetary aggregates are believed to be better predictors of future economic activity than traditional monetary aggregates and are tested to determine their ability to predict fluctuations in real output and prices. Domestic cash holdings are finally used to estimate the size of the U.S. unreported economy as measured by the amount of income that is not properly reported to the IRS. By 2010, we estimate that legal and illegal source unreported income” is $1.9–$2.4 trillion, implying a “tax gap” in the range of $400–$540 billion. Currently, we estimate that 18–23% of total reportable income is not properly reported to the IRS.

Quantifying the Shadow Economy: Measurement with Theory

We construct a dynamic, general equilibrium model of tax evasion where agents choose to report some of their income. Unreported income requires using a payment method that avoids recordkeeping – cash. Trade using cash to avoid taxes is the theoretical measure of the shadow economy from our model. We then calibrate our model using money, interest rate and GDP data to back out the size of the shadow economy for a sample of 30 countries and compare our estimates to traditional ad hoc estimates. Our results generate reasonably larger estimates for the size of the shadow economy than exist in previous literature.

Consumption of dairy products in the UAE: A comparison of nationals and expatriates

The variables: age, income, education, number of children, and a dichotomous dummy variable for nationality were used to explain the consumption behavior of dairy products: fresh milk, butter, cheese, yoghurt, powdered milk, condensed milk, cream, and ice cream in the urban centers of Al-ain, Dubai, and Abu Dhabi. Results suggest different determinants for consumption behaviors of nationals and expatriates as well as different determinants along the income range of the sample. Estimates for the expenditure elasticity were relatively higher for lower income groups when unreported income is taken into consideration in interpreting the results. Differences in consumption behavior bear an important implication to marketing and promotion of dairy products: different strategies that incorporate the different consumption determinants are perhaps necessary for the different ethnic groups.

An Empirical Analysis of Determinants of Recent Federal Personal Income Tax Evasion in the U.S.

Unaccounted for currency in die U.S. has been argued to reflect die presence of widespread income tax evasion. In turn, income tax evasion is especially problematic in this era of large government budget deficits and growing national debts which have led to debt crises. This empirical study seeks to identify determinants of recent federal personal income tax evasion in the U.S. using the most recent tax evasion data available, data that run through 2008 and are derived from the General Currency Ratio Model and measured in the form of the ratio of unreported AGI (adjusted gross income) to reported AGI. The empirical estimates find that personal income tax evasion is an increasing function of the maximum marginal federal personal income tax rate, the interest rate yield on three year Treasury notes, per capita real income, and a dummy variable for the years in which the second war in Iraq was conducted, while being a decreasing function of the Tax Reform Act of 1986, the ratio of the tax free interest rate yield on high grade municipals to the taxable interest rate yield on ten year Treasury notes, the audit rate by IRS (Internal Revenue Service) personnel, and the average IRS penalty on detected unreported income. Thus, among other things, this study finds that more aggressive IRS policies are effective tools in the war against personal income tax evasion.