Willful and non-willful tax evasion

It is often said that the only things certain in life are death and taxes. Taxes at least are far from inevitable, and at times individuals may take a number of actions to reduce their tax liabilities.

Individuals and firms can evade taxes by underreporting incomes, sales, or wealth; by overstating deductions, exemptions, or credits; or by failing to file appropriate tax returns. Indeed, there is widespread, if somewhat imprecise, evidence that tax evasion is extensive and common in nearly all countries, especially in developing countries.

The standard law of any country defines tax evasion as any attempt to avoid payment of taxes owed using illegal means. Every citizen and business has the right to take lawful steps to decrease their tax liability, including tax deductions and charitable contributions. However, avoiding payment of necessary taxes through illegal measures is criminal act and will lead to serious consequences.

The common type of tax evasion is failing to report cash income, reporting less than actual income, and hiding money in overseas accounts and improperly claiming tax deductions. Taking unauthorized deductions for personal expenses on a business tax return or falsely claiming (or inflating) charitable deductions are forms of tax evasion. Other types include filing a false tax return, omitting property, under reporting an estate’s value and overestimating the value of property donated to charity. Businesses may commit tax evasion by paying employees in cash and not filing proper returns.

Some are legal tax avoidance activities, such as income splitting, postponement of tax payments, and tax arbitrage across income that faces different tax treatment. Tax evasion consists of illegal and intentional actions taken by individuals to reduce their legally due tax obligations. The willful tax noncompliance, the difficulty of identifying this behaviour is reflected in the varying terms to which the analyses refer, such as “evasion,” “noncompliance,” “misreporting,” and “tax gap”. The term “evasion” is means for theoretical treatments of willful noncompliance. This is because despite the slim chances of being audited or reasonable penalties being imposed on tax evasion, most people are willing to abide by tax laws.

Tax evasion is widespread, always has been, and probably always will be. There is an old saying among tax professionals that “the poor evade, and the rich avoid,” meaning that the rich tend to reduce their taxes through legal “avoidance” measures such as tax shelters, while those with lower incomes attempt more outright evasion. Tax noncompliance seems related to some other observable characteristics of taxpayers. According to one study, married and taxpayers younger than 65 have significantly higher average levels of noncompliance than others, and men evade more than women. There also seems to be substantial heterogeneity in tax evasion. The US Taxpayer Compliance Measurement Program (TCMP) studies concluded that, within any group defined by income, age, or other demographic category, there are some who evade, some who do not, and even some who overstate tax liability. For example, for US taxpayers with reported income between $50,000 and $100,000 in 1988, 60 per cent understated tax, 26 per cent reported correctly, and 14 per cent actually overstated tax.

No government can announce a tax policy and then rely on the taxpayers’ sense of duty to remit what is owed. Some dutiful people will undoubtedly pay what they owe, but many others will not. Thus, paying taxes must be made a legal responsibility of citizens, with penalties attendant on noncompliance. But even in the face of those penalties, substantial tax evasion exists—and always has. Considerable experimental and anecdotal evidence suggests that cases of tax evasion involve much more than a moral cost–benefit calculation. A taxpayer who is deciding whether to comply with the tax law will weigh the expected cost of tax evasion against the cost of complying and choose the cheaper option.

In general, there is a large body of theoretical and empirical evidence to support the view that threat of punishment such as higher audit probabilities and penalties encouraged compliance and higher tax rates discouraged compliance. However, there are other studies that pointed to different direction.

There are mixed findings on the influence of penalties. A number of studies indicated a positive influence of higher penalty on tax compliance, but other studies lead to the opposite findings. The severity of the penalty may only discourage taxpayers from reporting their true incomes because the possibility of gaining is greater than the possibility of losing. In addition, the impact of penalty also varies according to group of taxpayers. For example, the severity of criminal fraud penalties was found to be positively related to the behavior of high-income self-employed individuals. On the other hand, penalties appeared to have negative relationships with the behaviours of small proprietors and middle-income individuals.

However, the direction of tax research has shifted since 1990s to try to understand the positive attitudes of taxpayers rather than the negative attitudes of taxpayers. It is understood that increasing extrinsic motivation—say with more punitive enforcement policies—may “crowd out” intrinsic motivation by making people feel that they pay taxes because they must, rather than because they want to. An experimental study finds that the level of cooperation in certain settings declines significantly when penalties are introduced, suggesting that the increased deterrence motivation did not compensate for the changes higher penalties bring about in how people frame their decisions.

Some survey evidence supports this view showing a positive relationship across countries between survey-based attitudes toward tax evasion on the one hand and professed trust in government, and other finds that the same relationship holds across individuals within the United States and Germany. A study in the Czech Republic indicated that a person would be more likely to evade taxes if that person believed government services were substandard. There is no such study by the government or possibly little academic research on evasion of tax in Bangladesh. Of course, such survey responses may well reflect after-the-fact rationalization of noncompliant behaviour.

Tax evasion is a criminal offense under any law of states, subjecting a person convicted to a prison sentence, fine, or both. An overt act is necessary to deter the crime of income tax evasion. Some tax understatement is, however, inadvertent error, due to ignorance of or confusion about the tax law. The dividing line between illegal tax evasion and legal tax avoidance is blurry. The law in Bangladesh has no such differentiation of motive of evasion.

Willfulness involves a voluntary, intentional violation of a known legal duty. In taxes, it applies for civil and criminal violations.  Income tax evasion is the willful attempt to evade tax law. Tax fraud occurs when a person or a company does any of the following: Intentionally fails to file an income tax return, willfully fails to pay taxes due, intentionally fails to report all income received, makes fraudulent or false claims, prepares and files a false return. Although the theory generally refers to willful understatement of tax liability, empirical analyses cannot precisely identify the taxpayers’ intent and therefore cannot precisely separate the willful from the inadvertent. Nor can the tax payers precisely distinguish the legal from illegal in complicated areas of the tax law.

The writer is a Legal Economist and adviser at Bangladesh Competition Commission. He can be contacted at [email protected]