Tax plays an important role to governments as a source of revenue to finance public expenditure, and it complements other sources of revenue. However, the problem of tax evasion by individuals is a menace in many countries. Illegal activities and loopholes in the tax system promote tax evasion. The current research paper intends to conduct a desktop research to gather facts surrounding the issue of tax evasion. First, the research focuses on the background of tax evasion, and this entails some of the factors promoting the vice. Second, the research captures the cost impact of tax evasion in the economy. Third, the research covers the means used to evade tax, and these include offshore accounts, transfer pricing, foreign investments as well as shell corporations. Fourth, the research also captures the various ways of addressing tax evasion, and these include elimination of hybrid entities, categorization of shell corporations as independent firms, empowering the internal revenue service, imposing strict penalties, addressing corruption problem, and sound management and administration of tax.
Taxes provide a significant source of government revenue to facilitate public expenditure. However, tax evasion by individuals and corporations threatens the government revenue collected through taxes. Tax evasion means the failure to pay taxes or report taxable income earned by an individual or a corporation. The evasion involves the illegal act of misrepresenting of incomes to the body tasked with the collection of taxes. As such, individuals or companies involved deliberately refuses to pay the amount that the government agency demands from them. In many countries, wealthy and poor people evade taxes, and, thus, the problem does not lie in a given socio-economic group of people. The problem contributes to the losses of government revenue, and it may make it hard for the government to fulfill its financial obligations. The problem of tax evasion affects many countries across the world. The governments response to the problem increases the costs of raising taxes, thus, increasing the government spending on tax collection. The problem of tax evasion stems from various factors including illegal activities, and people use various means to evade tax, while they inflict huge losses to the government and, in response, the government can take various measures to address the issue.
In countries like the United States, tax evasion is very serious, and, consequently, the tax gap is wide. The culprits misrepresent or conceal their actual earnings in what appears as dishonest tax reporting on profits, earnings, and other forms of gains. The tax gap is the difference between the amounts collected and what people owes the government. For instance, in 2007, the United States Internal Revenue Service recorded a total of $345 billion shortfall that was about 14% of the total revenue expected from taxpayers. In the United States, people who illegally earn money through theft, gambling and drug trafficking among other illegal activities are supposed to report their incomes, but they do not do this. However, it would be hard for these criminals to report their income due to the possibility of prosecution for non-tax related crimes. In addition, trying to disguise the money to make it appear from a legal activity also amounts to money laundering that is also punishable by law. As such, the country has made it hard for people with illegally earned money to declare their incomes, making them continue evading taxes. From the provided information, the government itself appears as an obstacle towards the elimination of tax evasion.
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Costs of Tax Evasion
The United States and other countries affected by tax evasion lose a great amount of money every year due to the discussed problem. Various approaches were adopted to estimate the tax avoidance by corporations dwell on information regarding income and assets. However, it is much harder to estimate the amount of money lost due to tax avoidance by individuals as the initial stage would require the estimation of assets owned abroad, and this may be hard as people do not report such income to the authorities. In addition, there would be the need to obtain the tax rate and the expected rate of return to estimate the revenue cost. As a result, it appears that it may be hard for the government to establish the amount of money lost because of individual tax evasion.
Several scholars attempted to estimate the amounts lost in tax evasion. For instance, basing on the estimated holdings by net worth that individuals invested outside the United States ($150 Trillion) there has been an estimated figure of $50 billion in lost money through tax evasion, and this is by the use of a tax rate of a third and a rate of return as 10%. The same calculations also reveal an annual international tax gap of $40 to $70. An individual tax evasion costs all countries in the world a total of $255 billion, and out of the whole amount, the United State loses $33 billion. The offshore wealth in the global level stands at $11 trillion. Under the current trend, it is evident that the losses experienced in the United States may hit $100 billion. From the above figures, it is evident that tax evasion inflicts huge losses not only to the United States but also to other countries since the evil has become an international evil.
Modes of Tax Evasion
People and firms use areas that charge low taxes to conceal their earnings and property. Shifting income to a country that levies low or no income tax sounds as tax avoidance since people and corporations commonly do this in the legal means. However, when a person or a corporation uses an offshore bank account to conceal a given type of income from their government, consequently, this qualifies as tax evasion. In fact, the act leads to a decline in the economy in figures between $40 and $70 billion per year. People commonly do this by withdrawing earnings from the investment and saving them in an offshore account without reporting the income to their government. For instance, in 2007, Switzerland enabled a large number of Americans to evade tax worth $20 billion. The factors promoting this vice are the bank secrecy and lack of transparency as well as the reluctance by countries to cooperate on tax laws. In addition, since the offshore country must be benefiting from the accounts held by foreigners in their land, it is hard for them to reveal the secret to the bankers native countries to avoid losing such revenue. From the provided information, it is evident that tax havens promote tax evasion in countries that impose more taxes on their citizens, and, thus, a country may not have the ability to deal with tax evasion without cooperation from the host countries.
The sale of services, machinery, and goods between related firms provides a loophole for tax evasion through transfer pricing. In transfer pricing, there is price fixing for the sale of the mentioned items, especially when such a deal takes place between a subsidiary and a parent company. For example, when a parent company sells the items to a subsidiary firm, the price is what people refer to as transfer price. In such a case, the parent firm, which operates in a non-tax haven area, sells the items to a subsidiary in the tax haven at extremely low prices and, accordingly, recording low profits in the non-tax haven area as a result of high production costs and low sales, reducing the tax liability on the firm. The subsidiary, in turn, sells back the goods to the parent firm at an inflated price, creating large profits that are free from tax. The parent company then documents large costs of production and lowers the taxable amounts on these profits. The problem of transfer price exists due to the inability of the developing nations to identify them and handle them accordingly. As such, there is the need for cooperation between the developed and developing countries to tackle the problem of transfer pricing.
Procurement of foreign investments is another way that people and firms use to evade tax. In the contemporary world, the Internet has globalized trade, making it possible for people to carry out transactions across the boundaries within a limited time. As such, individuals can purchase foreign investments in the form of stocks and bonds, and by doing this, they can easily bypass taxation in their host country. In addition, people can simply stash the money in their bank accounts and fail to report or pay tax, enabling them to go away with it. Due to the lack of withholding information about such activities, for instance, in the United States, taxpayers can easily evade tax. In regard to the provided information, it is evident that foreign investments in the form of bonds and stocks enable people to evade tax, and, thus, the government should devise ways of tackling and monitoring such activities.
Corporations also adopt structures that allow them to evade taxation. Some companies in the United States adopt some assemblies like the shell corporations and trust to enable them to bypass their tax obligations and due to lack of or poor information sharing. For instance, it is possible for the U.S. resident to evade taxation on domestic investments by simply launching an operation in the Cayman Islands by the use of technology. A person can simply register a bank account bearing the names of a business in Cayman, and this would cost a smaller fee considered to what tax would cost. An individual can then bank the money using electronic means and, therefore, bypass the tax authority. From the described information, it is evident that people use various firm structures to manipulate the tax system, enabling themselves to hide their incomes from the tax authority and as such, the government needs to seal this loophole.
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Addressing Tax Evasion
Countries need to eliminate the hybrid instruments and entities that enable people to evade taxes. Numerous organizations use some of the hybrid organization characteristics such as trust to conceal their profits as well as evade taxes. There is a need for countries to characterize and recognize firms in a consistent manner, and this should happen between countries. By so doing, the countries will address the problem that poses an obstacle to the matching of deductions and credits with income. For instance, all subsidiaries of companies must be recognized as individual business entities with a responsibility to pay tax, and this will help the government to frustrate the efforts by people to evade tax. From the information provided above, it is evident that inconsistencies in the classification of companies have provided a loophole for rogue investors to evade paying of tax and, so, the government needs to close the loophole.
Treating shell corporations as firms can also help to reduce tax evasion. Even though the U.S. government has attempted to address the issue, the efforts have not been so fruitful due to the loopholes in the existing as well as proposed laws Stop Tax Haven Abuse Act. The Act considers any firm that possesses assets worth over $50 million or that has an attribute of public trade as a corporation in the United States, and this law covers the hedge funds. However, the problem with the law is that it does not affect subsidiaries belonging to multinational firms as it considers such firms to be under the management of the parent firms. The law, thus, provides a loophole for those people who avoid the filing of tax returns and those who intend to evade paying tax. If the United States considers the shell corporations as firms, the unscrupulous business firms will avoid danger from underground deals to evade paying taxes. As such, the law seems ineffective, as it does not comprehensively address the problem of non-payment of taxes and obviously, there is the need to reshape the law so that it can address the problem exhaustively.
Empowering tax authorities is also important for countries as it helps strengthen the fight against non-payment of taxes through the improvement of capacity. For instance, the United States can empower the Internal Revenue Service body through increased funding and creation of additional vacancies for investigation and enforcement officers. Such improvements would empower the firm by refining its capacity to investigate overseas in order to abuse tax procedures. The actualization of a proposal to create 800 more positions in the organization would help to expand its powers and make it more effective in handling the cross-boundary cases of tax evasion. Concerning the provided information, it is advisable for the government to empower the revenue body by increasing the vital staff members to enable the firm to have the capacity to handle tax evasion cases that cross the international boundaries.
The government should also consider increasing penalties for those who violate the tax rules. The Stop Tax Haven Abuse Act as well as the Finance Committee Draft proposal includes the provision for increased penalties. The penalties targeted for the increase are those related to failure to file FBARs, abusing tax shelters, refusal to file information on alien trust, and clandestine offshore transactions. The implementation of the former President Obamas proposal to double penalties related to accuracy, trust irregularities, would be a boost to the fight against non-compliance in tax payment. There should also be the elimination of the legal opinions that a transaction is more likely than not to qualify for taxation will not provide immunity to taxpayers who violate tax obligations. The government should also implement the proposed Fraud Recovery and Investment Act without considering the critics view that it is too harsh to businesses and individuals. By making the punishment severe and punitive, the government would instill fear in those people who intend to violate tax obligations, and this means that people would have a lower probability of risking non-compliance. Concerning the provided information making punishments, more punitive would contribute to the governments success in taming tax evaders.
Dealing with corruption can help to reduce if not eliminating the problem of tax evasion. Corrupt tax officials or employees of the Internal Revenue Service work hand in hand to defraud the government with the unscrupulous business people who intend to evade their tax responsibility. The corrupt officials refrain from reporting cases of evasion so that they can receive bribes or illegal gratification. The officials also provide technical assistance to their illegal client by guiding them on how to manipulate the calculations and the whole tax system so that they successfully wade through the tax system without detection. The problem is evident both in developed and in the underdeveloped countries. Tax accountants and lawyers act as brokers to help taxpayers to evade their responsibility. The officers acting as clearing and forwarding agents also help people to evade customs duties when there is a transfer of assets across boundaries. The government thus needs to monitor the corrupt activities to tame the rogue revenue authority employees who aid tax evasion. Through measures such as staff training, digitalization of all activities, hefty punishments for corrupt officials, the government can effectively deal with the problem of tax evasion aided by corrupt officials. Indeed, the government needs to address corruption in the revenue service body to prevent the officers from abetting tax evasion.
The government also needs to ensure that there is sound tax administration and management. The Internal Revenue Service needs to administer and control taxes in a manner that does not seem too exploitative to people. When taxes charged are exorbitant, people have a higher likelihood to evade taxation so that they do not suffer too many financial losses. On the other hand, when taxes are favorable, people may not have much resistance or the tendency to evade the responsibility and, thus, the government will be able to collect taxes in an easy way that will not involve too much friction with people. There is no doubts that the government needs to make taxpayers to freely exercise their responsibility of paying taxes without much pressure, and this would be through making tax and tax system favorable to them so as to promote voluntary payment of tax.
Tax is a vital source of government revenue as it enables the government to finance the public expenditure. However, the problem of tax evasion or failure to pay taxes by some people and corporations is a serious problem affecting the whole tax system. Many factors including illegal activities and government failures promote tax evasion, as a resuly, the offenders use various means to cause harm to their government, and the latter can address the issue using various measures. In the United States, illegal activities as well as the measures preventing people who earn from such activities from declaring their income has been a major boost to tax evasion. Tax evasion has cost the United States and other countries billions of money in lost revenue. Among the ways of evading taxes as used by the offenders include offshore accounts transfer pricing, foreign investment in bonds and stocks, and offshore accounts among others and the tax haven countries play a large role in this scheme. Also, there are various means the government can employ to eliminate or reduce tax evasion. First, the government can eliminate hybrid entities. Second, treating shell corporations as independent firms can reduce the problem. Third, empowering the Internal Revenue Service through adequate staffing can help improve its capacity. Fourth, increasing penalties for tax defaulters can also discourage people from evading taxes. The fifth step would be addressing the corruption menace in the revenue service to instill discipline in workers. As a matter of fact, sound administration and management of tax and the tax system can improve voluntary payment of taxes by people and corporations. Finally, the problem of tax evasion is a serious issue, and it exists due to a number of loopholes, making it destructive to the economy, but the government can take various steps to address the problem of tax evasion to alleviate the harm to the economy.