Tax Compliance Increases as Tax Rates Decline

Tax Compliance Increases as Tax Rates Decline

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Last month in American Tax Compliance Rates Highest in Civilized World Despite What David Cay Johnston Says I refuted David Cay Johnston’s absurd claim that America’s low tax rates are the cause of it’s alleged rampant tax evasion:

Johnston claims that there is “rampant evasion in the U.S.” even though the very study he cites shows that there isn’t rampant tax evasion in the U.S. In fact, the study shows the very opposite: That the United States’ rate of compliance is the highest in the civilized world and it’s underground economy as a percentage of its economy is among the smallest.

… .

The reason America has a greater absolute amount of tax losses from tax evasion than do other countries is simply because it has a much larger economy than those other countries. America’s shadow economy as a percentage of its GDP is a mere 8.6%, by far the lowest of the ten countries included in the study. This, and not absolute dollars, is the important statistic in the study and one that should prompt all fair and impartial observers to assume what, even without the study, it is intuitive to assume: The lower the taxes, the greater the rate of compliance.

Now here comes Cato’s Daniel Mitchell reminding us once again of what is obvious to everyone but Mr. Johnston: The higher the tax rates, the greater the non-compliance:

Leftists want higher tax rates and they want greater tax compliance. But they have a hard time understanding that those goals are inconsistent.

Simply stated, people respond to incentives. When tax rates are punitive, folks earn and report less taxable income, and vice-versa.

In a previous post, I quoted an article from the International Monetary Fund, which unambiguously concluded that high tax burdens are the main reason people don’t fully comply with tax regimes.

Macroeconomic and microeconomic modeling studies based on data for several countries suggest that the major driving forces behind the size and growth of the shadow economy are an increasing burden of tax and social security payments… The bigger the difference between the total cost of labor in the official economy and the after-tax earnings from work, the greater the incentive for employers and employees to avoid this difference and participate in the shadow economy. …Several studies have found strong evidence that the tax regime influences the shadow economy.

Indeed, it’s worth noting that international studies find that the jurisdictions with the highest rates of tax compliance are the ones with reasonable tax systems, such as Hong Kong, Switzerland, and Singapore.

The above is an excerpt. Be sure to read the whole thing.

About Peter Pappas

Peter is a tax attorney and certified public acccountant with over 20 years experience helping taxpayers resolve their IRS and state tax problems.

He has represented thousands of taxpayers who have been experiencing difficulty dealing with the Internal Revenue Service or State tax officials.

He is a member of the American Association of Attorney-Certified Public Accountants, the Florida Bar Association and The Florida Institute of Certified Public Accountants and is admitted to practice before the United States Tax Court, the United States Supreme Court, U.S. District Courts - Middle District of Florida

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  1. David Cay Johnston says:


    The facts do not support what you assert.

    Tax compliance as officially measured by the IRS:

    Voluntary Compliance:
    Tax Year 2001

    Tax Year 2006


    AFTER enforcement

    Tax Year 2001

    Tax Year 2006


    And Singapore, low taxes? That’s another assertion unsupported by facts.

    As I revealed last summer (and the state-owned media there have never reported) Singapore has taxes that make the Swedes and Danes look like Norquistians.


    The government reports it earned a 5.2 percent real annual return over more than two decades, but pays just 1.2 percent. The facts are that Singapore imposes an implicit tax of almost 80 percent on capital earnings.

  2. David, you cherry-pick outliers.

    It’s common sense that tax compliance, like all things, is a risk-reward analysis. People break speed limits because the risk of being caught and the penalty for being caught is small. Only idiots rob gas stations because the money is small and the risk and penalty is high. Increasing tax rates incentivizes noncompliance.

  3. David Cay Johnston says:

    @ JD, I didn’t cherry-pick anything.

    I cited the official IRS report on the Tax Gap, which shows compliance decreased. How you can suggest that this is an outlier is beyond imagining.

    And your risk-reward analysis line is not rounded thinking. Ignore your assumptions for a moment. Now think about how lower tax rates would affect behavior at a 50% rate and a 10% rate and hopefully you will see what you missed. If not, then look up the behavioral research and study it and you will see where your assumptions mislead you.

    If your unclear “outlier” reference is to Singapore, I am not the one who stated as fact that Singapore is a low-tax jurisdiction. All I did was point out out that I exposed this last summer — unless, of course, you think an implicit 79% tax on capital incomes is, using the language from the post above, “reasonable.”