It's widely assumed that the biggest tax scofflaws are those with the most money. A new study by a team of IRS analysts and academic economists, however, tells us that things are much worse than anyone suspected.
The 1% conceal as much as 21% of their income from tax collectors, the study estimates. Of the unreported income, about 6 percentage points is hidden by "sophisticated evasion that goes undetected in random audits."
The unreported income for the 1%, households with more than about $420,000 in annual income, is as much as one-third higher than previously estimated, the authors wrote. For the 0.1%, households with at least $7.5 million in annual income, it's 80% higher.
While the income of taxpayers in the bottom 99% of the income distribution is comprehensively examined, up to 35% of the income earned at the top is not.
Guyton et al
The impact on the federal budget of evasion on this scale isn't trivial. The authors calculate that the top 1% are responsible for about 36% of all uncollected federal taxes and that collecting all that's due would garner about $175 billion a year. That's nearly 5% of federal revenues.
Its impact on estimates of economic inequality is also significant. Accounting for underreported income, the authors state, raises the estimate of the income share of the top 1% to 21.8% from 20.3% on average in 2006-2013.
The authors — John Guyton and Patrick Langetieg of the Internal Revenue Service, Daniel Reck of the London School of Economics, Max Risch of Carnegie Mellon University and Gabriel Zucman of UC Berkeley — say that the problem goes beyond an inadequate rate of random audits, which in any event have declined over the years.
The problem is that some forms of sophisticated evasion are "effectively invisible in random audits."
That's because much of the unreported income is hidden in foreign accounts or in "pass-through" businesses. These are businesses that aren't subject to the corporate income tax, but pass their income on to their owners to report on personal tax returns. The businesses are seldom audited. Consequently, as much as 28% of such income is underreported, the authors estimate.
The top 1% are able to use stratagems unavailable to other taxpayers. Most of the income reported by the bottom 99%, the authors note, comes in the form of wages, interest, dividends, capital gains and other income commonly reported to the IRS by employers, brokers or other third parties.
That's not true of pass-through businesses. Therefore, "while the income of taxpayers in the bottom 99% of the income distribution is comprehensively examined," they write, "up to 35% of the income earned at the top is not."
The study doesn't come at a good moment for the super-rich. President Biden is likely to propose raising tax rates on them to fund his economic initiatives, including a $3-trillion infrastructure program soon to be rolled out — or rather, restoring the tax rates on top brackets that were in place before former President Trump and a Republican-controlled Congress slashed them in 2017.
Meanwhile, Sen. Elizabeth Warren (D-Mass.) has re-upped her proposal for a wealth tax on the richest Americans, first offered during her presidential campaign in 2020.
Warren's Ultra-Millionaire Tax Act, cosponsored by Sen. Bernie Sanders (I-Vt.) — who also proposed a wealth tax during the campaign — and a host of Democratic senators and representatives, would impose an annual 2% levy on the net worth of households and trusts valued at more than $50 million and 3% on those valued at more than $1 billion. That would encompass about 100,000 households, or the top 0.05%, Warren says.
The tax would raise more than $3 trillion over 10 years, according to an analysis done for Warren by Zucman, the tax evasion study coauthor, and his UC Berkeley colleague Emmanuel Saez.
Biden shares Warren's view that "middle-class families are paying more than their fair share and those at the top are not doing their part," White House Press Secretary Jen Psaki said on March 15. "Obviously ... corporations could be paying higher taxes."
Pressure on Congress to give the IRS more resources to unearth hidden income among the wealthy is also intensifying.
As IRS Commissioner Charles P. Rettig told a House Ways and Means Committee panel on March 18, the agency's budget has fallen to less than $12 billion this year from $14.6 billion in 2010 — a decline of some 20% accounting for inflation.
This hasn't been by accident: Congress has systematically reduced the IRS enforcement budget in full awareness that less enforcement means that the wealthy get to keep more of their income and wealth rather than paying their fair share.
The result of the budget cuts is a 31% shrinkage in the number of enforcement agents and a 48% reduction in those dealing with the most difficult and complex tax evasion cases. The audit rate for individual tax returns, Rettig said, fell by about 45% between 2010 and 2019 and by 72% for businesses with assets of $10 million or more.
"It's not just a body count of how many people we have in enforcement," Rettig said, "but with respect to the higher-income taxpayers, we need to have specialized agents."
There's no question that stricter enforcement pays for itself — $5 to $7 recovered for every dollar spent on enforcement, Rettig told the committee.
Lax enforcement may have contributed to increasingly bold tax evasion. As I reported last year (based on an analysis of IRS data by David Cay Johnson), 23,456 U.S. households reported income of $10 million or more for the 2018 tax year, averaging more than $26 million each in taxable income. The IRS audited seven of them.
That comes to less than three-hundredths of a percent, or about the chance of being struck by lightning at some point in your lifetime. So it may not be surprising that wealthy taxpayers don’t think they have much reason to fear the IRS.
This story originally appeared in Los Angeles Times.