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Friday, November 26, 2004

The Rich are Different....


The Millionaire
Tax Cheat
Next Door
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Our last post ended with a cliffhanger question: Are rich folks just a bunch of tax cheats? Time for some academic research. What does the evidence say?

The answer is probably not what you expect. First, tho, let's think about definitions, because in political economy the way a question is framed generally shapes the answer. When we say "rich", what images or stereotypes are we bringing to mind? Are we describing the top 20% of the population? The top 1%? The Forbes 400 richest Americans? Are we looking at people with high incomes or high net worth? Is our data pool composed of individuals, of families, or of tax return filing units? It makes a difference. Similarly, we need to start thinking clearly about what it means to "cheat" -- since the term can cover a range of behavior, from sloppy arithmetic errors to technically legal "creative compliance" to cold-blooded criminal evasion. We don't want to be like those loud anti-tax troglodytes who attack all the works of government as "waste, fraud and abuse" and whose gargantuan "fraudulent spending" numbers simply add up the cost of all programs they don't personally like or support.

Because the word "rich" is both hopelessly vague and loaded with emotion, let's use more neutral terms, like "tax return filers with incomes in the top 1%". To translate that into dollars, look at the most recent IRS Statistics of Income data for returns filed during year 2003 that reported income and tax for 2002. (Time lags are inevitable with tax statistics.) In order to make it into the top 1% that year, one would have to show income over $285,000 (technically, "Adjusted Gross Income = "income after subtracting the cost of getting it"). Already there are at least three potential distortions in the data: (1) a tax filing unit may be one person or may be husband and wife combining two incomes onto one return: (2) the denominator is inflated by the many returns filed for children and other dependents with minor amounts of income that does not reflect their real family economic circumstances -- about half of the 24 million returns reporting income under $10,000 are in this category, and (3) the statistics describe income as reported by taxpayers, but we are trying to learn about unreported income and similar dishonesty. Because the truly successful cheat is an undetected cheat, we will always be somewhat limited in understanding the extent of our ignorance.

It's not nice to accuse folks of cheating, whether it's true or not, so let's use more neutral terms like "noncompliance". Think of it as "difference between income/tax as originally shown on return and income/tax proposed by experienced revenue agent after thorough examination". This is the so-called "tax gap" that the IRS probed with its "Taxpayer Compliance Measurement Program" (a/k/a the "Audits from Hell") back in the 1980's. (This was before the Republicans gained control of Congress in the 1994 elections and told the IRS to stop annoying the voters.) Again, some potential sources of distortion need to be mentioned -- it seems as tho under close examination the tax noncompliance data keeps jittering around, like quantum particles under Heisenberg's microprobe. For example, 12% of the total amount of proposed increases in income tax liability that resulted from these intense line-by-line audits was later dropped as the result of taxpayer appeals or court proceedings. And it is really, really hard to detect all unreported income, so the IRS uses a fudge factor -- on the basis of an old (1976) study, the Service assumes that for every dollar detected there is another $3.28 that has flown below the revenue radar and has missed hitting the books.

The next posts in this series will try to organize the evidence about hi-income noncompliance and explain what it means. As teasers, tho, here are some tentative conclusions:

The Rich cheat on their taxes, but not as much as they should.golden

[According to the economists, that is].

The Rich cheat on their taxes, but it's not their fault.

[Say the white-collar crime sociologists].





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