Tax noncompliance


Tax noncompliance is a range of activities that are unfavorable to a government's tax system. This may include tax avoidance, which is tax reduction by legal means, and tax evasion which is the illegal non-payment of tax liabilities. The use of the term "noncompliance" is used differently by different authors. Its most general use describes non-compliant behaviors with respect to different institutional rules resulting in what Edgar L. Feige calls unobserved economies. Non-compliance with fiscal rules of taxation gives rise to unreported income and a tax gap that Feige estimates to be in the neighborhood of $500 billion annually for the United States.
In the United States, the use of the term 'noncompliance' often refers only to illegal misreporting. Laws known as a General Anti-Avoidance Rule statutes which prohibit "tax aggressive" avoidance have been passed in several developed countries including the United States, Canada, Australia, New Zealand, South Africa, Norway and Hong Kong. In addition, judicial doctrines have accomplished the similar purpose, notably in the United States through the "business purpose" and "economic substance" doctrines established in Gregory v. Helvering. Though the specifics may vary according to jurisdiction, these rules invalidate tax avoidance which is technically legal but not for a business purpose or in violation of the spirit of the tax code. Related terms for tax avoidance include tax planning and tax sheltering.
Individuals that do not comply with tax payment include tax protesters and tax resisters. Tax protesters attempt to evade the payment of taxes using alternative interpretations of the tax law, while tax resisters refuse to pay a tax for conscientious reasons. In the United States, tax protesters believe that taxation under the Federal Reserve is unconstitutional, while tax resisters are more concerned with not paying for particular government policies that they oppose. Because taxation is often perceived as onerous, governments have struggled with tax noncompliance since the earliest of times.

Differences between avoidance and evasion

The use of the terms tax avoidance and tax evasion can vary depending on the jurisdiction. In general, "evasion" applies to illegal actions and "avoidance" to actions within the law. The term "mitigation" is also used in some jurisdictions to further distinguish actions within the original purpose of the relevant provision from those actions that are within the letter of the law, but do not achieve its purpose. All pursue the same immediate goal, minimising the amount paid.
In particular, in the American legal system, tax evasion is a criminal action disciplined by 26 US Code §7201, under which the taxpayer who fails to pay or willfully underpays his tax liability will undergo criminal penalties. On the other side of the coin, tax avoidance happens when the taxpayer tries to lessen his tax obligation using deductions and credits to maximize after-tax income. All of this is considered legal by the IRS even though it foresees civil penalties. All things considered, the main difference between tax evasion and tax avoidance is the taxpayer's guilty mind of minimization or failure to pay the tax liability.

Tax gap

The U.S. Internal Revenue Service provides formal definitions: "The gross tax gap is the difference between true tax liability for a given tax year and the amount that is paid on time. It is the nonfiling gap, the underreporting gap, and the underpayment gap. The net tax gap is the portion of the gross tax gap that will never be recovered through enforcement or other late payments."

Underground economy and tax gap

An important way to study the tax gap is to examine the size of the tax gap in a country by analyzing the size of the underground economy and its influencing factors. The size of the underground economy is directly related to the institutional infrastructure. The institutional infrastructure of a country mainly includes the intensity of government regulation, the establishment and implementation of laws, the degree of judicial independence, the size of effective tax rates, the effective provision of public goods or services, and the effective protection of property rights. It is generally believed that the higher the level of government regulation, the greater the size of its underground economy and the greater the tax gap. And vice versa, when government over-regulation occurs, an alternative relationship exists between the size of the underground economy and the size of the official economy. Representatives of this view are Levenson, Maloney, and Johnson. They believe that higher tax rates can raise higher tax revenues, and the government can provide higher levels of public services accordingly, thereby attracting more companies and individuals out of the underground economy, resulting in a healthy balance of "high tax rates, high taxes, high public services, and small-scale underground economy", but low-tax countries, because they do not have enough income to provide high levels of public services, will form a vicious balance of "low tax rates, low taxes, low public services, and high-scale underground economy." In the above-mentioned healthy balance, the tax gap is relatively small; in the vicious equilibrium, the tax gap is relatively large.

Tax customs and tax gaps

Tax custom is different from tax avoidance or tax evasion. It does not measure the taxation behavior of individuals, but the tax attitude of individuals. The tax custom can also be considered as the moral responsibility of the individual. Making a specific contribution to society by paying taxes on the government must fulfill this responsibility. It embodies the ethical code of conduct for individuals in taxation, although it does not require the form of law. The decline or deterioration of taxation practices will reduce the moral costs of taxpayers engaging in illegal operations or underground economic activities.
An empirical study by ALM on transition countries such as Russia found that there is a strong negative relationship between tax customary variables and underground economic size variables . And both variables are significant at the 1% level.
Bird believed that a sustainable and efficient tax system must be based on perceived fairness and goodwill response to taxation. It must be connected organically with the provision of public goods or services. If taxpayers see their preferences reflected in governance and see efficient provision of government services, they stay in the official economy and fulfill tax obligations. Tax revenues increase while the tax gap narrows.
The economic experiments cited by Torgler and Schaltegger show that the extensive exercise of voting rights in tax affairs will significantly increase taxpayer compliance. The deeper the taxpayer participates in political decision making, the higher the tax contract performance efficiency and tax compliance. The taxpayer society in this state is a civil society with tax and good customs, and the taxpayer is a real citizen who has been given a wide range of powers.
Everest Phillips believes that the design of a reasonable and effective tax system is an important part of the construction in a country. The operation of this tax system must be based on the higher compliance of taxpayers and the goodness of taxation rather than relying on coercive measures. He pointed out that as the country's tax system for building important content must have the following five important characteristics:
  1. Political participation. The wide participation of taxpayers in the political decision-making process is an important guarantee for establishing social taxation and good customs. When taxpayers lack effective access to decision-making, they will be concerned about tax revenue collection and the lack of efficiency in the provision of public goods or services. Tax compliance will be reduced, and taxation practices are likely to deteriorate. As a result, tax evasion scale will expand and tax gaps will increase. This situation will further weaken the ability of government to provide public goods or services, and thus trap the construction process into a vicious cycle.
  2. Responsibility and transparency. The government should have a legitimate duty to use tax revenues, and procedures for providing public goods or services should be transparent to taxpayers.
  3. Perceivable fairness. In a reasonable and effective tax system, taxpayers can perceive themselves as being treated equally and justly. With regard to tax incentives or tax exemptions, if taxpayers perceive that they are being treated unfairly, their tax willingness will inevitably decline.
  4. Effectiveness. The government should have the ability to transform gradually increasing tax revenues into higher levels of public goods or services and enhance political stability.
  5. Sharing a prosperous political commitment. The national taxation system should be closely linked with the national goal of promoting economic growth. Promoting economic growth is one of the strategic goals that the government has promised to taxpayers. The government can promote the realization of this strategic goal through taxation.

    Tax collection management efficiency and tax gap

Under the premise of economic development level, the ability of a country to raise tax revenue is mainly determined by the tax system design in the country and the efficiency of its collection and management. From the perspective of taxation practices in various countries, the design of taxation system is affected and restricted by the efficiency of tax collection and management. Therefore, it can be said that the relative size of a country's tax revenue collection and tax gap is closely related to the tax collection and management efficiency of the s tax administration agencies in the country.
A reasonable explanation for the introduction of value-added tax by most developing countries in the world is to increase the taxpayer's compliance with tax payment through the mutual supervision mechanism between taxpayers without increasing the cost imposed by the tax administration authorities. This consideration for the factors of taxation determines that developing countries can only adopt the tax system that is mainly based on turnover tax. From the perspective of taxation, due to restrictions on the level of taxation in developing countries, tax revenues can only be raised through indirect taxes that focus on taxes such as value-added tax and consumption tax, while direct taxes represented by income taxes and property taxes are included in total tax revenue. The proportion is relatively low. Bird and Zolt pointed out that, contrary to the practice of taxation in developed countries, personal income tax still plays a very limited role in developing countries today, both in terms of income mobilization and adjustment of income disparities. In 2000, the income tax income of developed countries was 53.8% of total income, compared with 28.3% in developing countries. They believe that wages and other income of workers in the informal sector in developing countries are still free from tax collection. The same is true of the property tax situation. Due to the lack of necessary information and assessment mechanisms for the assessment of property values, property taxes cannot be successfully implemented in many developing countries; even if developing countries with property taxes exist, their income collection is still insufficient. From the above analysis, we can see that compared with indirect taxes, developing countries still have a large tax gap in terms of direct taxes.