What the Top 1% Are Hiding From the IRS

What the Top 1% Are Hiding From the IRS


Tax evasion among the wealthiest Americans is more substantial than previously estimated, according to a new paper published by the National Bureau of Economic Research.

The analysis by a team of academic and federal researchers finds that the top 1% of taxpayers fail to report about 21% of their income to the IRS. This misreporting is largely by design, the product of sophisticated strategies by wealthy households to avoid paying taxes. For the richest 0.1%, the numbers are even more significant, with unreported incomes nearly twice as large as previous IRS estimates indicated.

Two key strategies to avoid taxation involve the use of offshore accounts and pass-through businesses, both of which are “quantitatively important” to households at the top of the income ladder, the researchers said. Random audits by the IRS often fail to detect income hidden within those structures, and the problem appears only to be getting worse.

Overall, the report estimates that unpaid income tax for in the top 1% totals at least $175 billion per year.

“There is more revenue than you might have thought at the very top,” Daniel Reck of the London School of Economics, one of the paper’s five authors, told The Wall Street Journal.

A taxing proposal: One major problem for the IRS is that the agency has no good way to verify business income. Wage earners receive W-2 forms from their employers, which capture more than 90% of wages paid and greatly reduce the ability to cheat, but there is no such system for businesses. Two years ago, the IRS estimated that more than half of all business income goes unreported, leaving billions in profits, rent and royalties untaxed each year. Those missing taxes form the biggest chunk of the $600 billion the IRS says goes unpaid every year.

A potential solution to the problem is to create something like a W-2 system for businesses. The New York Times editorial board made the case for such an option, building on a proposal from Charles Rossotti, who led the IRS from 1997 to 2002. Rossotti argued that simply assigning more investigators to examine the tax returns of the wealthy is insufficient. Instead, he proposed that banks should send annual income statements for businesses to the IRS, similar to the 1099 forms sent to investors every year.

Interestingly, such a system wouldn’t change the amount anyone owes in taxes. All it would do is create a system that makes it harder to cheat. “It would have the immediate benefit of scaring people into probity,” the Times said.

By way of instructive comparison, the Times noted that starting in 1986, taxpayers for the first time were required to provide Social Security numbers for all those being claimed as dependents. As a result, about 7 million children disappeared from the nation’s tax returns in just one year.

The Times also called for a big increase in funding for the IRS, which has faced crippling budget cuts over the last decade. An analysis published last fall by Rossotti and two co-authors, former Treasury Secretary  Lawrence Summers and University of Pennsylvania law professor Natasha Sarin, argued that a $100 billion investment in the tax agency over 10 years would enable the IRS to collect $1.4 trillion in unpaid taxes over 10 years.

“The logic of such an investment is overwhelming,” the Times said. “The government can crack down on crime, improve the equity of taxation — and raise some needed money in the bargain. There are many proposals to raise taxes on the rich. Let’s start by collecting what they already owe.”

Growing interest in taxing the rich: In addition to closing loopholes and beefing up enforcement,  President Joe Biden’s economic team has been pushing more aggressively to raise taxes on the wealthy, Bloomberg’s Nancy Cook reported Monday, spurred by data showing that those on the upper rungs of the economic ladder have done very well during the Covid-19 pandemic. The revenues raised by the new taxes will be used to help those in the middle and at the bottom who have been left behind, both during the coronavirus crisis and over a longer period stretching back decades.

Biden has hired several advisers who have written extensively on how to go about taxing the rich, including New York University Law School professor David Kamin, who now serves as deputy director of the National Economic Council. Kamin told Bloomberg that the administration is currently considering a number of options, including a minimum tax for big businesses, raising the capital gains tax rate, and removing the “step-up basis” on estates that allows long-term capital gains to go untaxed when passed onto heirs.

Passing these reforms “would be major accomplishments, which would pretty fundamentally shift how our tax system treats the richest Americans and the largest corporations so they can’t escape tax in the ways they now can,” Kamin said.