Responses to Questions for the Record
Ways & Means Committee
February 22, 2011
Evasion at the Individual Tax Payer Level
What are the statistics regarding tax evasion by individuals?
The starting point for any statistics relative to tax evasion begins by looking at the available data regarding the tax gap. The tax gap is defined as the amount of income owed to the federal government compared to the amount actually received. The estimated tax gap is about $345 billion, but after enforcement efforts the total is closer to $290 billion.
About 70 percent of the gross tax gap is attributable to the individual income tax. The individual income tax is the largest source of federal receipts.
Determining the reason for the tax gap is more difficult. Intentional evasion is difficult to measure, since it requires an intentional act and we can only measure those taxpayers who have been caught. In addition, a certain amount of the tax gap is the product of errors.
From the perspective of small business owners, simplifying the tax code would be a good way to help address these problems. A simplified tax code will reduce errors and also provide fewer opportunities for those looking to evade their tax obligations.
We know the high U.S. corporate tax rate is not the only factor that U.S. companies consider when deciding where to locate future investments and that companies also consider such things as the workforce, ease of access to raw materials, quality of the infrastructure, stability of the legal and political environment, the location of customers and the cost of shopping finished goods to them, etc. Can you help explain how companies weigh these factors and how large- or small- a factor the U.S. statutory tax rate is?
Your question outlines the main issues a business raises in determining where to locate future investments. The tax rate is certainly part of that consideration. For most small businesses, the statutory corporate rate is less of a factor than for a larger business. First, most small businesses are organized as pass through entities – about 75 percent – so they do not pay the corporate tax rate, but the individual tax rate. Second, fewer small business operate abroad so the corporate tax rate relative to the rest of the world is less of an issue.
That being said, tax rates are an important decision for any business owner. For smaller businesses, the federal tax rate is only part of the consideration. They must also consider the state and local tax rates, which when stacked with the federal rates in some states are creeping towards 50 percent. This is why keeping the individual tax rate low is so important for small businesses. The money that a business earns is often put back into the business or used to start another business. A successful small business will look for the next opportunity – either opening another branch or diversifying into another business. This is one factor that makes the small businesses a driver of job creation. Raising the individual tax rate deters capital formation and reduces the ability of small business owners to make the investment in new firms.