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\author{230B: Public Economics \\ Emmanuel Saez}

\date{Berkeley}

\title{Tax Enforcement} \onlyslides{1-300}

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\begin{document}

\begin{slide}
\maketitle
\end{slide}

\begin{slide}
\begin{center} {\bf Tax Enforcement Problem} \end{center}

Most models of optimal taxation (income or commodity) assume away
enforcement issues. In practice:

\vskip2ex

1) Enforcement is costly (eats up around 10\% of taxes collected
in the US) when combining costs for government (tax administration) and private
agents (tax compliance costs)

\vskip2ex

2) Substantial tax evasion (15\% of under-reported income in the
US federal taxes). Tax evasion much worse in developing countries

\vskip2ex

Two widely used surveys:

Andreoni, Erard, Feinstein JEL 1998

Slemrod and Yitzhaki Handbook of PE, 2002

\end{slide}

\begin{slide}
\begin{center} {\bf ALLINGHAM-SANDMO JPUBE'72 MODEL} \end{center}

Seminal in the theoretical tax evasion literature. Uses the Becker
crime model

Individual taxpayer problem:
$$\max_{\bar{w}} \:\: (1-p) \cdot u(w-\tau \cdot \bar{w}) + p \cdot u(w -\tau \cdot \bar{w} -
\tau (w-\bar{w})(1+\theta)),$$ \noindent where $w$ is true income,
$\bar{w}$ reported income, $\tau$ tax rate, $p$ audit probability,
$\theta$ fine factor, $u(.)$ concave.

Let $c^{No \:Audit}=w-\tau \cdot \bar{w}$ and $c^{Audit}=w -\tau
\cdot \bar{w} - \tau (w-\bar{w})(1+\theta)$

FOC in $\bar{w}$: $-\tau(1-p)u'(c^{No \:Audit})+p \theta \tau
u'(c^{Audit})=0 \Rightarrow$
$$\frac{u'(c^{Audit})}{u'(c^{No
\:Audit})} = \frac{1-p}{p \theta}$$

SOC $\Rightarrow$ $\tau^2 (1-p)u''(c^{No
\:Audit})+p\tau^2\theta^2u''(c^{Audit})<0$

\end{slide}

\begin{slide}
\begin{center} {\bf ALLINGHAM-SANDMO JPUBE'72 MODEL} \end{center}

{\bf Result:} Evasion $w-\bar{w}$ decreases with $p$ and
$\theta$

Proof $d\bar{w}/dp>0$: Differentiate FOC with respect to $p$
and $\bar{w}$:

$-dp \cdot \tau u'(c^{No \:Audit}) - d\bar{w} \cdot  \tau^2 (1-p)
u''(c^{No \:Audit})  \\ = dp \cdot \theta \tau u'(c^{Audit}) +
d\bar{w} \cdot p \theta^2 \tau^2 u''(c^{Audit})$

$\Rightarrow$ $ d\bar{w} \cdot [- \tau^2 (1-p) u''(c^{No \:Audit})
- p \theta^2 \tau^2 u''(c^{Audit}) ] \\ = dp \cdot [ \theta \tau
u'(c^{Audit}) + \tau u'(c^{No \:Audit}) ]$

Similar proof for $d\bar{w}/d\theta>0$

%In this model $d\bar{w}/d\tau>0$: $d\tau$ creates income effect
%$\bar{w} \uparrow$ [risk aversion] and substitution effect
%$\bar{w} \downarrow$ [pays to evade more]

Huge literature built from the {\bf A-S} model [including optimal
auditing rules]
\end{slide}



\begin{slide}
\begin{center} {\bf Why is tax evasion so low in OECD countries?} \end{center}

{\bf Key puzzle:} US has low audit rates ($p\simeq.01$) and low fines
($\theta \simeq .2$). With reasonable risk aversion (say CRRA
$\gamma=1$), tax evasion should be much higher than observed
empirically

Two types of explanations for puzzle

1) {\bf Unwilling to Cheat:} Social norms and morality [people
dislike being dishonest and hence voluntarily pay taxes]

2) {\bf Unable to Cheat:} Probability of being caught much
higher than observed audit rate because of {\bf 3rd party
reporting}:

Employers double report wages to earners and govt (W2 forms), companies and
financial institutions double report capital income paid out to
individuals and govt (US 1099 forms)

\end{slide}

\begin{slide}
\begin{center} {\bf DETERMINANTS OF TAX EVASION} \end{center}

Large empirical literature studies tax evasion levels and the link
between tax evasion and (a) tax rates, (b) penalties, (c) audit
probabilities, (d) prior audit experiences, (e) socio-economic
characteristics

Early literature relies on observational [non-experimental]
data which creates serious identification and measurement issues:

(1) Evasion is difficult to measure

(2) Most independent variables [audits, penalties, etc.] are
endogenous responses to evasion and also difficult to measure

$\Rightarrow$ Requires to use experimental data or to find good
instruments: (a) IRS National Research Program (NRP),
(b) lab experiments, (c) field experiments
\end{slide}


\begin{slide}
\begin{center} {\bf Tax gap in the United States} \end{center}

Results from latest National Research Program (NRP) studies (IRS 2022) for 2014-2016

IRS carries out \textbf{random} audits to specifically estimate the tax gap

1) Total tax gap (= taxes evaded / taxes owed) around 14\% 

%2) No clear trend over time

2) Tax gap concentrated among income items with no 3rd party
reporting (such as self-employment income)

3) Withholding reduces tax gap (liquidity constraint $\Rightarrow$ some
taxpayers can never pay taxes owed unless withheld at source)

\end{slide}



%\begin{slide}
%\begin{center} {\bf TCMP: IMPACT OF THIRD PARTY REPORTING} \end{center}
%
%IRS Tax Compliance Measurement Study (TCMP) is a thorough audit of
%stratified sample of tax returns done periodically. TCMP shows that:
%
%1) Tax Gap is about 14\%
%
%2) Tax Gap concentrated among income items with no 3rd party
%reporting (such as self-employment income)
%
%$\bullet$ tax gap over 50\% when little 3rd party reporting
%[consistent with Allingham-Sandmo]
%
%$\bullet$ Tax Gap very small ($<5\%$) with 3rd party reporting
%
%\end{slide}

\begin{slide}
\includepdf[pages={1,2}]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\begin{center} {\bf NRP: METHODOLOGICAL ISSUES} \end{center}

%3) Tax Withholding further reduces tax gap: liquidity constraint
%effect is most likely explanation: some taxpayers can never
%pay the tax due unless it is withheld at source
%
%$\Rightarrow$ wage income withholding is critical for enforcement
%of broad based income tax and payroll taxes

Numbers from NRP are rough estimates because audits cannot
uncover all evasion 

$\Rightarrow$ Thorough audits detect evasion of only about 4\% of income

IRS uses a parametric econometric model with auditors' fixed effects to blow up evasion found by factor 3 (Feinstein '91): 

\textbf{Detection Controlled Estimation (DCE) methodology:} \\ Key idea: some auditors are better than others 

$\Rightarrow$ Very sensitive to assumptions 

Guyton et al. 21 point out that NRP misses (a) offshore tax evasion and (b) evasion in passthrough business tax returns

$\Rightarrow$ Tax evasion more concentrated toward the rich than NRP 


%TCMP cannot be used to study convincingly causal impact of audits
%or fines on evasion

\end{slide}

\begin{slide}
\includepdf[pages={29-33, 49, 34}]{taxenforcement_attach.pdf}
\end{slide}


\begin{slide}
\begin{center} {\bf LAB EXPERIMENTS} \end{center}

Multi-period reporting games involving participants (mostly
students) who receive and report income, pay taxes, and face risks
of being audited and penalized

1) Lab experiments have consistently shown that penalties, audit
probabilities, and prior audits increase compliance (e.g., Alm,
Jackson, and McKee, 1992)

2) But when penalties and audit probabilities are set at realistic
levels, their deterrent effect is quite small [Alm, Jackson, and
McKee 1992] $\Rightarrow$  Laboratory experiments tends to predict
more evasion than we observe in practice

Issues: Lab environment is artificial, and therefore likely to
miss important aspects of the real-world reporting environment
[3rd party information and social norms]
\end{slide}


\begin{slide}
\begin{center} {\bf FIELD EXPERIMENTS} \end{center}

1) Blumenthal, Christian, Slemrod NTJ'01 study the effects of
normative appeals to comply: treatment group receives letter
encouraging compliance on normative grounds ``support valuable
services'' or ``join the compliant majority'', control group [no
letter]

$\Rightarrow$ No (statistically significant) effect of normative
appeals on compliance overall

2) Slemrod, Blumenthal, Christian JPubE'01 study the effects of
``threat-of-audit'' letters

$\Rightarrow$ Statistically significant effect on reported income
increase, especially among the self-employed [``high opportunity
group''] but very small sample size

\small
Recently: (a) Hallsworth et al. '17 show that normative appeals help in collecting
overdue taxes [but small quantitatively], (b) Bott et al. 2020 for a randomized experiment in Norway on
foreign income [threat of audit more effective than normative appeal], (c) see survey Luttmer-Singhal '14
 

\end{slide}

\begin{slide}
\includepdf[pages={3}]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\includepdf[pages={4}]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\begin{center} {\bf TAX AUDIT EXPERIMENT FROM DENMARK} \end{center}

Kleven-Knudsen-Kreiner-Pedersen-Saez '11 analyze bigger Danish
income tax auditing experiment [stratified sample 40,000]

Overall detected evasion [no adjustment] is around 2.5\% but:

1) Evasion rate for self-reported items is almost 40\%

2) Evasion rate for third party reported items is only 0.3\%

3) Overall evasion rate is so low because 95\% of income is third
party reported in Denmark

Role of 3rd party reports [information structure] seem to trump
social factors and economic factors:

%$Evade_i = \alpha + \beta Self\: Reported \: Income_i + \gamma Social\: Factors_i + \varepsilon_i$
\end{slide}



\begin{slide}
\includepdf[pages={5}]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\includepdf[pages={15}]{taxenforcement_attach.pdf}
\end{slide}


\begin{slide}
\includepdf[pages={16}]{taxenforcement_attach.pdf}
\end{slide}

%
%\begin{slide}
%\includepdf[pages={14,15}]{pdf/TaxComplianceExperimentOct2009K.pdf}
%\end{slide}

\begin{slide}
\begin{center} {\bf TAX AUDIT EXPERIMENT FROM DENMARK} \end{center}
Kleven et al. '11 also provide experimental causal effects of:

\textbf{1) Marginal tax rates:} use bunching evidence before and after audit:
Most bunching not due to evasion but avoidance $\Rightarrow$ Effect of MTR on evasion is
modest

\textbf{2) Prior-audit effects:} compare next year outcomes of 100\% audit
group and a 0\% audit group [as audited tax filers may update
upward beliefs on $p$]

$\Rightarrow$ Find significant effects on reported income
increases, concentrated among self-reported items [nothing on 3rd
party income]: Extra tax collected through this indirect effect is about 50\% of
extra taxes collected due to base year audits

\textbf{3) Threat-of-audit letters:} Find significant effects on
self-reported income increases [as in Slemrod et al.] and letter prob matters

\end{slide}

\begin{slide}
\includepdf[pages={7,8,9,11}]{taxenforcement_attach.pdf}
\end{slide}


%\begin{slide}
%\includepdf[pages={19,20}]{pdf/TaxComplianceExperimentOct2009K.pdf}
%\end{slide}


%\begin{slide}
%\begin{center} {\bf ADDING THIRD PARTY REPORTING IN A-S MODEL: KLEVEN-KREINER-SAEZ '09} \end{center}
%
%Income $w=w_t+w_s$ where $w_t$ is third party reported (observed
%by govt at no cost) and $w_s$ is self-reported (as in standard
%Allingham-Sandmo model). Individual reports $\bar{w}_t$ and
%$\bar{w}_s$
%
%1) $\bar{w}_t=w_t$ because audit rate is 100\% for this income
%category
%
%2) Government audits $\bar{w}_s$ with probability $p<1$ (costly):
%$$\max_{\bar{w}_s} \:\: (1-p) u(w- \tau w_t - \tau \bar{w}_s) + p u(w-\tau w_t - \tau \bar{w}_s -
%\tau (w_s-\bar{w}_s)(1+\theta))$$ $$\Leftrightarrow
%\max_{\bar{w}=w_t+\bar{w}_s} \:\: (1-p) u(w - \tau \bar{w}) + p
%u(w - \tau \bar{w} - \tau (w-\bar{w})(1+\theta))$$
%
%$\Rightarrow$ {\bf 3rd Party Irrelevance:} If no constraints on
%$\bar{w}_s$, 3rd party reporting does not help enforcement
%
%Note: irrelevance result remains true if $p(\bar{w})$
%\end{slide}
%
%
%\begin{slide}
%\begin{center} {\bf BREAKING THE IRRELEVANCE RESULT} \end{center}
%
%Irrelevance result depends on 2 strong assumptions:
%
%(1) Self-reported losses are allowed
%
%(2) Audit rate does not depend on (sign of) $\bar{w}_s$
%
%More realistic models where irrelevance breaks down:
%
%(1) Disallow self-reported losses 
%
%(2) Audit rate $p$ depends (negatively) on $\bar{w}_s$
%
%$\Rightarrow$ 3rd party reporting helps government enforce taxes
%
%\end{slide}

\begin{slide}
\begin{center} {\bf EXPLAINING ACTUAL TAX POLICIES} \end{center}
Income $w=w_t+w_s$ where $w_t$ is third party reported (observed
by govt at no cost) and $w_s$ is self-reported (as in standard
Allingham-Sandmo model).

Incorporating 3rd party reporting solves
puzzles of the {\bf Allingham-Sandmo} model:

1) Evasion rates are high in $s$ sector (consistent with {\bf Allingham-Sandmo})
and low in $t$ sector

2) IRS sets audit rate $p$ higher when $\bar{w}_s<0$ (small business losses,
undocumented deductions, etc.) to protect $w_t$ base

3) $\bar{w}_s$ losses not allowed against $w_t$ (example: US
limits capital gain losses and passive business losses)

4) Use of schedular income taxes (tax separately various bases): Earliest
income taxes (1800-1900) are {\bf schedular}
\end{slide}


\begin{slide}
\begin{center} {\bf SIMPLER MODEL OF TAX EVASION} \end{center}
$$u=(1-p(\bar{w})) \cdot [w-\tau \cdot \bar{w}]+ p(\bar{w}) \cdot [ w \cdot (1-\tau) - \theta \cdot
\tau \cdot (w-\bar{w})]$$

FOC $du/d\bar{w}=0$ $\Rightarrow$ $[p ( \bar{w}) - p' ( \bar{w})
(w-\bar{w})]( 1+\theta) =1$

Introduce the elasticity of the detection probability with respect
to undeclared income: $\varepsilon = -(w-\bar{w})
p'(\bar{w})/p(\bar{w})>0$
$$1=p ( \bar{w}) \cdot ( 1+\theta) \cdot (1+\varepsilon )$$ 
%Marginal benefit of evading \$1 extra = Marginal
%cost of evading \$1 extra

If $\varepsilon=0$, then always evade if $1>p \cdot (1+\theta)$

If $\varepsilon>0$, then evading more increases risk of being
caught on all infra-marginal evaded taxes $\Rightarrow$ Even with
$\theta=0$, full evasion is not always optimal

Shape of $p(\bar{w})$ depends crucially on 3rd party income
\end{slide}

\begin{slide}
\includepdf[pages={12}]{taxenforcement_attach.pdf}
\end{slide}


\begin{slide}
\begin{center} {\bf WHY DOES THIRD PARTY REPORTING WORK?} \end{center}
In theory, employer and employee could collude to evade taxes
$\Rightarrow$ third-party does not help (Yaniv 1992)

In practice, such collusion is fragile in modern businesses bc:

1) Accounting and payroll records that are widely used within the
firm [records need to report true wages in order to be useful to run
a complex business]

2) A single employee can denounce collusion between employer and
employees. Likely to happen
in a large business [disgruntled or new employee, whistle blower seeking govt reward]

$\Rightarrow$ Taxes can be enforced even with low penalties and
low audit rates [Kleven-Kreiner-Saez 2016, Jensen 2022]

\end{slide}


\begin{slide}
\begin{center} {\bf Limits of 3rd Party Reporting in Devo Context} \end{center}

Feinmann-Hsu-Lauletta '22 conduct a large survey among formal workers in Brazil.
Key findings:

1) Partial unreported pay is widespread, sizable,
and proportionally larger for higher income workers

2) Generally suggested by the employer (80\%) and paid with cash (50\%) or electronic payments (40\%)

3) Bunching at ceiling for pension payroll taxes for workers aged 55+ provides ``observational'' confirmation
of split of pay into formal wage + unreported wage

4) Labor lawsuit (citing ``payment under the table'') increases formal pay in the firm $\Rightarrow$ Workplace
conflict reduces evasion

Conclusion: Cracking down on these payments is possible but obviously hard to do if everybody does it

\end{slide}


\begin{slide}
\includepdf[pages={52-56}]{taxenforcement_attach.pdf}
\end{slide}


%\begin{slide}
%\begin{center} {\bf FORMAL MODEL OF 3RD PARTY} \end{center}
%
%1) Firm has $N$ employees where wages=marginal productivity
%$w=(w_1,..,w_N)$ (assume away profits).
%
%2) Firm and employees cooperatively report
%$\bar{w}=(\bar{w}_1,..,\bar{w}_N)$ to govt which applies constant
%tax rate $\tau$
%
%3) If firm uses {\bf accounting records} then $w, \bar{w}$ known
%within firm by all employees
%
%4) If $w \neq \bar{w}$, any employee can show {\bf accounting
%records} to govt and denounce cheating
%
%5) Govt cannot observe $w$ if all employees collude
%
%6) Govt applies fine at rate $\theta>0$ for evaded taxes
%
%\end{slide}
%
%
%\begin{slide}
%\begin{center} {\bf FORMAL MODEL OF 3RD PARTY} \end{center}
%
%Firm and all employees can {\bf collude} to report
%$\bar{w}=(0,..,0)$ and evade taxes entirely
%
%But collusive equilibrium is fragile as a single employee can
%reveal cheating. Can happen because of:
%
%1) Random Shocks: Work conflict, Moral Concerns, Mistake
%
%2) Whistle blowing reward: Govt offers fraction $\delta$ of unpaid
%taxes to whistle blowers
%
%$\Rightarrow$ Collusive equilibrium harder to sustain in large
%firms
%
%\end{slide}
%
%
%\begin{slide}
%\begin{center} {\bf FORMAL MODEL OF 3RD PARTY: RANDOM SHOCKS} \end{center}
%
%If $w \neq \bar{w}$, each employee denounces firm with probability
%$\varepsilon$ (iid) $\Rightarrow$ Firm successfully evades with
%prob. $(1-\varepsilon)^N$
%
%Firm/workers set $\bar{w}$ to maximize ex-ante expected surplus
%(assuming risk neutrality):
%$$S=\sum_n [w_n - \tau \cdot \bar{w}_n - (1-(1-\varepsilon)^N) \cdot
%\tau \cdot (1+\theta) \cdot (w_n-\bar{w}_n)]$$ $$\partial S /
%\partial \bar{w}_n = \tau \cdot
%[-1+(1+\theta)(1-(1-\varepsilon)^N)]$$ Firm/workers evade (fully)
%iff $(1-\varepsilon)^N > \theta/(1+\theta)$
%
%Large firms do not evade even for small $\varepsilon$ and $\theta$
%
%\end{slide}
%
%\begin{slide}
%\begin{center} {\bf FORMAL MODEL OF 3RD PARTY: WHISTLE BLOWER
%MODEL}\end{center}
%
%Govt offers reward fraction $\delta$ of uncovered taxes to whistle
%blowers ($\delta<\theta$).
%
%Audit probability is 0 if nobody whistle blows and 1 if anybody
%whistle blows. Whistle blowers share fraction $\delta$ of unpaid
%taxes $\tau \sum_{n'} (w_{n'} - \bar{w}_{n'})$
%
%If $w \neq \bar{w}$, nobody whistle blows iff
%
%$w_n - \tau \bar{w}_n \geq w_n - \tau \bar{w}_n - (1+\theta)\tau
%(w_n-\bar{w}_n) + \delta \tau \sum_{n'} (w_{n'} - \bar{w}_{n'})$
%
%iff $(1+\theta)(w_n-\bar{w}_n) \geq \delta \sum_{n'} (w_{n'} -
%\bar{w}_{n'})$ for all $n$ $\Rightarrow$ $1+\theta \geq N \delta$
%
%$\Rightarrow$ No collusive tax cheating is sustainable iff $\delta
%> (1+\theta)/N$ $\Rightarrow$ Large firms do not evade even with
%small $\delta$ and $\theta$
%\end{slide}

%\begin{slide}
%\begin{center}
%{\bf INCOME TAXATION IN DEVO COUNTRIES}
%\end{center}
%Progressive individual income taxes in devo countries are small and limited to a small
%fraction of upper income taxpayers (vast majority of the population are informal self-employed workers)
%
%Kleven and Waseem QJE'13 study income tax in Pakistan
%
%Tax creates notches because \textbf{average} tax rate jumps
%$\Rightarrow$ Bunching below the notch and gap in density just above the notch
%
%\textbf{Empirically:} Evidence of bunching (primarily among self-employed)
%but size of the response is quantitatively small
%
%Large fraction of taxpayers are unresponsive to notch likely  due to lack of information
%
%\end{slide}
%
%\begin{slide}
%\includepdf[pages={20,18-19,21}]{taxenforcement_attach.pdf}
%\end{slide}
%
%
%\begin{slide}
%\begin{center}
%{\bf Kleven and Waseem QJE'13 notch analysis}
%\end{center}
%With optimization frictions (lack of information, costs of adjustment),
%a fraction of individuals fail to respond to notch
%
%Kleven-Waseem use density above notch to measure the fraction
%of unresponsive individuals
%
%This allows them to back up the frictionless elasticity (i.e. the elasticity
%among responsive individuals)
%
%The frictionless elasticity is much higher than the reduced form elasticity
%but remains still relatively modest
%
%
%\end{slide}



\begin{slide}
\begin{center} {\bf HISTORY OF TAX COLLECTION} \end{center}
Interesting to understand why taxes develop the way they do
[Webber-Wildavsky '86 book, Ardant '71 book in French]

During most of history, governments were under the tax enforcement
constraint: they were collecting as much taxes as possible given
the economic / informational conditions

Many developing countries today still face such tax enforcement
constraints

Earliest taxes are tributes: conquerors / rulers realize that it
is more lucrative to raise periodic tributes than outright
raiding

\end{slide}

\begin{slide}
\begin{center} {\bf FROM ARCHAIC TO MODERN TAXES} \end{center}

1) Coercive state from 3000BC-1900AD: rise of despotic kingdoms, invent taxes (and writing) and forced labor
to serve power of hierarchical state (Scott 2017)

Governments try to extract revenue through rules without
destroying economic activity and without generating tax revolts:
``plucking the goose while minimizing hissing'' (Colbert)

Combination of poll taxes, land taxes, product taxes (tithe), excise taxes, tolls, govt monopolies
(govt size $\leq$ 10\% of GDP supports only regalian public goods)

European countries have largest states and largest military to colonize world
(Piketty 2020)

2) Rise of social state in 20th century: modern taxes based on formal businesses (payroll taxes,
income taxes, VATs) with big govt 30-50\% of GDP serve population rather than state
\end{slide}



\begin{slide}
\begin{center}
{\bf Taxation as the Origin of States}
\end{center}
States first arise through warfare and conquest in productive areas (e.g. Nile Valley) to extract taxes (see Carneiro, 1970)

Modern test of this theory: Sanchez JPE'20 surveys Eastern Congo villages in war areas 

Bandits establish ``local states'' (=order and taxes) when village tax potential is high

(a) villages with coltan mineral have tax potential particularly when coltan price is high

(b) villages with gold mineral do not have tax potential (bc gold can be easily hidden)

Likelihood of taxation of coltan mining sites follows coltan price
\end{slide}

\begin{slide}
\includepdf[pages={27}]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\includepdf[pages={28}]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\begin{center}
{\bf Taxation and State Building}
\end{center}
Weigel QJE'20 shows that citizens' engagement increases when taxes are enforced better

Field experiment randomizing property tax collection improvements across 356 neighborhoods of a large city in Congo
(door to door registration and in-person appeals to pay)

First stage: property tax compliance: 0.1\% in control to 11.6\% in treatment. 

Second stage: town hall attendance meetings or submitting local govt evaluations increased 5 points (or 31\%)

%$\Rightarrow$ Paying more taxes increases public mindedness of citizens

Reverse causality: From public goods to taxes:
Krause '21 finds in randomized experiment in Haiti that providing municipal garbage removal increases property tax compliance by 27\% (and reduces localized political violence by 85\%)

\end{slide}

\begin{slide}
\includepdf[pages={36, 35}]{taxenforcement_attach.pdf}
\end{slide}


%\begin{slide}
%\begin{center} {\bf ARCHAIC TAXES} \end{center}
%
%Governments try to extract revenue through rules without
%destroying economic activity and without generating tax revolts
%
%Colbert (17th century France) famous expression: ``plucking the
%goose while minimizing hissing''
%
%{\bf Direct taxes:} taxes on property, businesses, or people
%
%{\bf Indirect taxes:} taxes on transactions and exchanges
%
%Classification is no longer very meaningful: [estate tax is
%direct, inheritance tax is indirect but economically equivalent]
%\end{slide}
%
%
%
%
%
%\begin{slide}
%\begin{center} {\bf ARCHAIC DIRECT TAXES}\end{center}
%
%{\bf Poll tax} (fixed amount per person). Cannot raise much
%revenue as poor cannot pay much [people flee or rebel, serfdom is
%a way to prevent fleeing behavioral response]. Later
%differentiated by class (nobility, peasants, professions).
%
%{\bf Land tax} (amount per lot), later differentiated by quality.
%Cannot raise much unless carefully differentiated with expensive
%land registry [otherwise marginal lands abandoned]
%
%{\bf Product taxes} (such as tithe = fraction of gross
%agricultural product): Tax requires monitoring production. Tax on
%gross product can be overwhelming for marginal lands
%
%$\Rightarrow$ Archaic direct taxes can hardly raise more than 5\%
%of total product in primitive economies. Hard to collect in barter
%economies. Only minimal govt can be supported.
%\end{slide}
%
%\begin{slide}
%\begin{center} {\bf ARCHAIC INDIRECT TAXES} \end{center}
%
%Indirect taxes require exchange economies %because based on
%movements of people and goods
%
%{\bf Tolls} for use of roads, rivers, entering towns, crossing
%borders, harbors, mountain pass. Initially based on people, later
%based on goods transported [overused when no coordination across
%jurisdictions]
%
%{\bf Excise and Sales Taxes} on exchanged goods. In early
%economies, only few goods are traded: salt, metal, alcohol
%beverages. Fairs where exchanges are concentrated also allow
%governments to impose sales taxes
%
%{\bf Govt Monopoly} Some economic activities require use of heavy
%equipment (grinding wheat, pressing grapes) $\Rightarrow$ Can be
%controlled/monitored by govt
%
%$\Rightarrow$ Archaic indirect taxes can raise substantial
%additional revenue in jurisdictions with substantial trading
%activity %[Italian towns, Holland towns]. Easier to collect as
%money is used for exchanges.
%\end{slide}
%
%\begin{slide}
%\begin{center} {\bf MODERN TAXES} \end{center}
%Modern taxes exploit {\bf accounting information} that is required
%in large/complex business activities and {\bf withholding at
%source}
%
%Shift from differentiated capitation and presumptive taxes (on
%businesses and individuals) toward modern income taxation
%
%Shift from excise taxes toward general sales taxes and VAT
%
%Modern taxes can collect 50\% of GDP without harming
%growth
%
%Modern taxes in rich countries today are threatened primarily by
%(a) tax havens [enforcement difficult], (b) international tax
%competition [requires international coordination], (c) marginally
%the informal sector
%
%\small IMF recommendations for poor countries to switch from archaic
%tariffs to modern VAT reduced tax revenue bc VAT enforcement failed [Cage-Gadenne 13]
%\end{slide}






%\begin{slide}
%\begin{center}
%{\bf EMPIRICAL PATH OF GOVERNMENT GROWTH}
%\end{center}
%1) Govt size is small (typically $<$ 10\% of GDP) in Western
%countries before industrialization (Flora '83). Use {\bf archaic}
%taxes: [poll taxes, land-property taxes, product taxes, excise
%taxes, tolls, tariffs]
%
%2) Govt size increases sharply in all advanced economies during
%20th century. Increase corresponds to the development of {\bf
%modern} taxes enforced using business records [income taxes,
%payroll taxes, value added taxes]
%
%3) Govt growth has slowed or stopped in most advanced economies
%over last 3 decades
%
%This general historical pattern applies to almost all rich
%countries although timing and final govt size varies across
%countries
%\end{slide}
%
%\begin{slide}
%\includepdf[pages={13,14}]{taxenforcement_attach.pdf}
%\end{slide}
%
%
%


%\begin{slide}
%\begin{center}
%{\bf Explaining Pattern of Govt Growth with Tax Enforcement (Kleven-Kreiner-Saez '09)}
%\end{center}
%
%
%1) Early development: economy is rudimentary and business are
%small / do not need business records: government cannot use modern
%taxes and is constrained by limited fiscal capacity 
%$\Rightarrow$
%Government size is too small relative to citizens' preferences
%
%2) Middle development: businesses grow in size and start using
%records $\Rightarrow$ Government can start using modern taxes and
%grows (still constrained by fiscal capacity as too high taxes
%would make businesses go back to informality)
%
%3) Late development: economy is largely formal $\Rightarrow$
%Government no longer constrained, govt size optimal given citizens'
%preferences $\Rightarrow$ Government size (relative to
%GDP) is stable
%\end{slide}
%
%\begin{slide}
%\begin{center}
%{\bf ALTERNATIVE THEORIES OF GOVT GROWTH}
%\end{center}
%1) Demand elasticity for public goods has income elasticity above
%one [{\bf Wagner's law} $\sim 1900$] (can't explain stability since 1980)
%
%2) Supply side: Stagnating productivity in the government sector
%[Baumol's '67 {\bf Cost Disease Theory}] (can't explain stability since 1980)
%
%3) {\bf Ratchet effect theory}: temporary shocks (e.g., wars)
%raise government expenditures, which do not fall back after the
%shock because of changed social norms [Peacock-Wiseman '61,
%Besley-Persson '08] (can't explain Sweden and pre-20th century
%wars)
%
%4) {\bf Political economy} theories based on voting and
%democratization, etc.
%
%%5) {\bf Leviathan theory} Bureaucrats maximize govt size subject
%%to fiscal capacity and political constitution constraints
%\end{slide}
%

\begin{slide}
\begin{center}
{\bf VARIOUS SALES TAXES}
\end{center}
{\bf Turnover taxes} used to tax all sales: business to consumer
(B-C) and business to business (B-B):

Creates multiple layers of taxes along a production chain
$\Rightarrow$ Higher total tax when B-B-C than B-C

{\bf Retail Sales Tax} is imposed on B-C sales only [B-B exempt]:
difficult to distinguish B-B and B-C (shifting), strong evasion
incentive for B-C [sales tax does not work well with small retailers]

{\bf Value-Added-Tax (VAT)} taxes only value added [sales minus
purchases] in all transactions (B-B and B-C): equivalent to retail
sales economically but easier to enforce [automatic upstream enforcement]

VAT first introduced in France in 1950s, has spread to most countries
[US only rich country without VAT] %yet little research

%VAT is huge quantitatively yet little VAT research (lack of data)

\end{slide}

%\begin{slide}
%\begin{center}
%{\bf NO EVASION: VAT $\Leftrightarrow$ RETAIL SALES TAX }
%\end{center}
%(1) Supplier $S$ produces material using only labor inputs and
%sells it for $s$, pays VAT $\tau \cdot s$
%
%(2) Manufacturer $M$ buys material for $s$ and sells product for
%$m$, pays VAT $\tau \cdot (m-s)$
%
%(3) Retailer $R$ buys product for $m$ and sells good to consumers
%for $r$, pays VAT $\tau \cdot (r-m)$
%
%Total VAT is $\tau \cdot r$
%
%Retail sales tax paid only by $R$: $\tau \cdot r$
%
%VAT $\Leftrightarrow$ Retail sales tax
%\end{slide}
%
%\begin{slide}
%\begin{center}
%{\bf INTRODUCING EVASION}
%\end{center}
%Government matches the purchases and sales VAT reports: need to be
%consistent: $\bar{s}$, $\bar{m}$, $\bar{r}$
%
%If $M$ and $R$ truthfully report $\bar{m}=m$, $\bar{r}=r$: if $S$
%decides to evade $\bar{s}<s$, $M$ has to pay $\tau \cdot
%(m-\bar{s})$, $M$ will only purchase at lower price $\Rightarrow$
%No gain for $S$ to evade
%
%Similarly, if $R$ truthfully reports $\bar{r}=r$, then $M$ (and
%hence $S$) cannot evade
%
%VAT compliance down the chain forces compliance upstream [even if
%upstream businesses are informal]
%
%If $R$ is big and uses business records (Walmart) then $R$ cannot
%misreport $\bar{r}$ $\Rightarrow$ VAT will work well [but retail
%sales tax would also work]
%
%\end{slide}
%
%\begin{slide}
%\begin{center}
%{\bf WHY VAT WORKS BETTER?}
%\end{center}
%
%If $R$ is small / informal, it can evade but needs to report at
%least $\bar{r}=\bar{m}$ [otherwise VAT credit would attract tax
%audit]
%
%If $M$ is small / informal and if $R$ evades and sets
%$\bar{r}=\bar{m}$, then $M$ can evade VAT by colluding with $R$:
%both $R$ and $M$ can decide to lower both $\bar{r}$ and $\bar{m}$
%equally
%
%... $S$ can also evade if $M$ and $R$ evade
%
%If all firms are small / informal, VAT enforcement is impossible
%
%If bottom firm $R$ is small / informal $\Rightarrow$ Retail sales
%tax breaks down entirely but VAT does not:
%
%If bottom firm $R$ is small / informal but $M$ is large / formal,
%VAT enforcement will work from $M$ and upstream
%
%\end{slide}

%\begin{slide}
%\begin{center}
%{\bf ENFORCEMENT OF VAT VS RETAIL SALES TAX}
%\end{center}
%
%1) Sales tax enforcement depends critically on retailers. Sales tax
%can be enforced with large retailers but much harder with small retailers
%
%2) VAT: when there is a large/formal firm in the production chain, then
%enforcement upstream takes place automatically. Imports often play this role
%as they are easy to observe and tax [Keen '07]
%
%3) VAT Issues: (a) VAT evasion easier with international
%transactions [carousel fraud], (b) VAT cannot tax easily financial
%services.
%\end{slide}

\begin{slide}
\begin{center}
{\bf POMERANZ AER'15 VAT EXPERIMENT}
\end{center}
Randomized experiment with 445,000 firms in Chile: sent threat of VAT audit letters to sub-sample of businesses

\textbf{Key Results:}

1) Significant effect of letters on VAT collection (+10\% over 12 months)

2) Smaller impact on
reported transactions that already have a paper trail
(intermediate sales) than on those which don't (final sales)

3) Effect of random audit announcement is transmitted up the VAT chain, increasing compliance
by firms' suppliers

\end{slide}

\begin{slide}
\includepdf[pages={22-26}]{taxenforcement_attach.pdf}
\end{slide}


\begin{slide}
\begin{center}
{\bf WEALTH IN TAX HAVENS ZUCMAN QJE'13}
\end{center}
Official statistics substantially underestimate the net foreign asset positions of rich countries 
because they do not capture most of the assets held by households in off-shore tax havens

\small
Example: US individual opens a Cayman Islands account and buys
mutual fund shares (composed of US stock): Cayman Islands record a liability
but US do not record an asset (because this is not reported in the US) 
\normalsize

$\Rightarrow$ Total world liabilities are larger than world total assets

Zucman compiles all financial stats and estimates that around 8\% of the global financial wealth of households is held in tax
havens (three-quarters of which goes unrecorded = 6\%)

Top 1\% holds about 50\% of total financial wealth $\Rightarrow$ 12\% of financial wealth of the rich is
hidden in tax heavens

\small
Alstadsaeter-Johannesen-Zucman JpubE'18  use Bank for International Settlements (BIS) data to distribute offshore wealth across
countries of origin

\end{slide}




\begin{slide}
\begin{center}
{\bf DISTRIBUTIONAL WEALTH IN TAX HAVENS}
\end{center}
Alstadsaeter-Johannesen-Zucman AER�19 link data from HSBC leak of accounts to Norwegian tax data

Complete file of the clients of HSBC Switzerland was leaked in
2007 and obtained by tax authorities

HSBC: large bank ($\simeq$ 5\% of Swiss offshore wealth)

Accounts frequently held through shell companies, but HSBC
recorded identity of beneficial owners

Clear-cut way to identify evasion by linking to tax returns of clients: linking done in Scandinavia

Similar exercise done for Panama Papers leak and tax amnesty

Londono-Avila '21 show that Panama Papers leak increased voluntary disclosure
of evasion for Colombia wealth tax 
\end{slide}

\begin{slide}
\includepdf[pages={38-41}, scale=1.2]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\includepdf[pages={50}, scale=1.1]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\includepdf[pages={51}, scale=.95]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\includepdf[pages={37}, scale=.95]{taxenforcement_attach.pdf}
\end{slide}

%\begin{slide}
%\begin{center}
%{\bf CURBING OFF-SHORE TAX EVASION}
%\end{center}
%Off-shore tax evasion possible because of bank secrecy: US cannot get a list
%of US individuals owning Swiss bank accounts from Switzerland
%
%$\Rightarrow$ No 3rd party reporting makes tax enforcement very difficult
%
%In principle, problem could be solved with exchange of information across
%countries BUT need all countries to cooperate
%
%Johannesen-Zucman AEJ-EP'14 analyze tax haven crackdown: 
%G20 countries forced number of tax havens to sign bilateral treaties
%on bank information sharing
%
%Key result: Instead of repatriating funds, tax evaders
%shifted deposits to havens not covered by treaty with home country.
%
%\end{slide}


\begin{slide}
\begin{center}
{\bf CURBING OFF-SHORE TAX EVASION}
\end{center}

Rich individuals can evade taxes on wealth and capital income using offshore accounts
in tax havens with bank secrecy

US passed FATCA in 2010: requires foreign banks to report accounts owned by US persons to IRS
or face stiff penalties

$\Rightarrow$ Almost all banks complied (Panama papers leak risk)

$\Rightarrow$ Extended to all OECD+G20 countries in 2014: \textbf{Common Reporting Standard}

$\Rightarrow$ Harder today to evade taxes through offshore accounts

\small
Casi et al. 2020 shows that cross-border deposits in tax havens have declined by 12\% after adoption (but still scope for evasion)

Real estate not subject to CRS has become more attractive to companies incorporated in tax havens (Bomare-Le Guern 2022 study London)

%2022 sanctions against Russian oligarchs shows need for transparency of offshore ownership
%(Italy proposed international public register of wealth for Russian oligarchs)

\end{slide}


\begin{slide}
\begin{center}
{\bf Tax Avoidance of Multinational Corporations}
\end{center}


{\bf Multinational firms}: Firms that operate in multiple countries. Foreign branches of the firm
are called subsidiaries.

%{\bf Subsidiaries}: The production arms of a corporation that are located in other nations.

{\bf Territorial tax system}: Corporations earning income abroad pay taxes to countries in which the income is earned (most countries use this system)

{\bf Global tax system}: Corporations are taxed by their home countries on their income regardless of where it is earned (with tax credit for foreign corporate taxes paid)


US had global tax system before 2018 (but foreign profits were taxed only when ``repatriated'')

%US system in 2018+: territorial system but with modest minimum tax of 10.5\% on foreign profits (with foreign tax credit)

%Biden campaign proposed to beef up minimum tax

%(US system before 2018 but foreign profits were taxed only when ``repatriated'')
%
%{\bf Foreign tax credit}:
%U.S.-based multinational corporations may claim a credit against their U.S. taxes for any tax payments made to foreign governments when funds are repatriated to the US parent.

%{\bf Repatriation}:
%The return of income from a foreign country to a corporation's home country.
\end{slide}

\begin{slide}
\begin{center}
{\bf Repatriation Tax Holidays (before 2018)}
\end{center}
\vspace{-0.5cm}

In US pre-2018, owners eventually wanted the income repatriated from abroad and paid out to them as dividends

Corporations paid normal (old) corporate tax  35\% tax on foreign profits upon repatriation

Massive amount of profits accumulated abroad (about \$2.5 Tr by 2018) $\Rightarrow$ Temptation for politicians to offer repatriation tax holiday

\small
American Jobs Creation Act of 2004: Reduced tax rate on repatriated profits from 35\% to 5.25\% for 2005 only: surge in repatriations in 2005 (by \$250bn) followed by reductions in repatriations in subsequent years 

$\Rightarrow$ Net tax loser and no surge in investment
\normalsize


2018 Trump tax reform forces repatriations over 2018-2025 with 15.5\% tax on cash and 8\% on other assets and imposes min tax of 10.5\% on new foreign profits with foreign tax credit

\end{slide}


\begin{slide}
\includepdf[pages={46}, scale=1]{taxenforcement_attach.pdf}
\end{slide}



%\begin{slide}
%\begin{center}
%{\bf Inversions}
%\end{center}
%
%Other way for U.S. corporations to dodge U.S. corporate tax: change country of incorporation to a tax haven
%
%Cannot just say ``I'm an Irish corporation now.'' Must merge with an Irish corporation first, called ``corporate inversion''
%
%Ex. Medtronic (maker of heart pacemakers) merged with Irish Covidien in 2014 $\rightarrow$ Declared legal headquarters in Ireland $\rightarrow$ Avoided U.S. tax on \$14bn held overseas
%
%
%
%
%Potential rationale for low U.S. corporate tax rate: Corporations will move headquarters/jobs overseas
%
%No evidence though that many actual jobs move (e.g. Medtronic kept operational headquarters in Minnesota)
%\end{slide}



\begin{slide}
\begin{center}
{\bf Tax Avoidance of Multinationals (Zucman '14)}
\end{center}
Share of profits made abroad by US corporations is about 1/3 today (was less than 5\% in the 1930s)

50\% of foreign profits of \textbf{multinationals} are reported in tax havens (such as Ireland)


Multinational companies are particularly savvy to avoid corporate income tax
by reporting most of their profits in low tax countries using \textbf{transfer pricing}: one subsidiary buys/sells to another
at manipulated prices to transfer profits

Example: Google located its search engine algorithm in Bermuda and Google Bermuda leases it to Google US, Google EU, etc.

Profits are moving to tax havens but not workers nor real capital $\Rightarrow$ This is a tax avoidance story



%$\Rightarrow$ Effective corporate tax rate is lower than nominal US Federal tax rate


\end{slide}

\begin{slide}
\includepdf[pages={43}, scale=1]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\includepdf[pages={48, 47}, scale=1]{taxenforcement_attach.pdf}
\end{slide}

\begin{slide}
\begin{center}
{\bf Issues with new US Corporate Tax System}
\end{center}
Since 2018, US has a very low corporate tax rate of 21\%

$\Rightarrow$ Strong incentives for successful business owners to incorporate 
and keep profits inside the corporation and pay only 21\% (instead of higher top individual tax rate)

$\Rightarrow$ This can undermine the progressive individual income tax

If business is a multinational: profits abroad are taxed at an even lower 10.5\% tax rate (with foreign tax credit)
and only on supernormal profits in excess of 10\% of capital abroad. 

$\Rightarrow$ Multinationals still have strong incentives to shift profits abroad in tax havens
(Garcia-Bernardo, Jansky, Zucman '21)

Declining corporate tax rates worldwide due to harmful tax competition (re-inforces inequities created by globalization)

\end{slide}

\begin{slide}
\includepdf[pages={42}, scale=1]{taxenforcement_attach.pdf}
\end{slide}


\begin{slide}
\begin{center}
{\bf Taxing Multinational Companies more Effectively}
\end{center}
Current territorial system where multinationals choose where to report
profits is easy to game. Need a better system: Several possibilities:

1) Tax on global profits in real time (each country taxes its multinationals on global profits with
credit for foreign taxes)

2) Minimum tax on foreign profits country-by-country: min tax needs to be high enough to discourage use of tax havens 

3) Apportioning profits based on sales in each country [as states are doing within the US and as EU new digital tax]

Probably need a combination of these and have strong anti-inversion regulations so
that it's hard for multinationals to change nationality [Saez-Zucman 2019 discussion]

\end{slide}

\begin{slide}
\begin{center}
{\bf 2021 Global minimum tax agreement}
\end{center}
Recent international agreement October 2021 (136 countries) 

Each country will police its own multinationals by imposing a
minimum tax of 15\% on foreign profits country-by-country:

Apple pays 5\% on its profits in Ireland, US charges extra 10\%

$\Rightarrow$ Kills the pure tax haven model but 3 weaknesses:

a) 15\% is low relative to domestic corporate tax rates

b) Carveout: Min tax applies only on profits in excess of 5\% of payroll+tangible capital deployed 
$\Rightarrow$ Multinationals have incentives to move \textbf{real operations} to low
tax places

c) Sales apportionment replacing EU digital tax is tiny

\small
Conclusion: tax low but shows this is technically solvable. US has not passed it yet
(legislation is part of stalled Build Back Better bill)
\end{slide}



\begin{slide}
\begin{center}
{\bf REFERENCES}
\end{center}
{\small

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