Tax Evasion - How It Affects the Economy Worldwide - Essay Example

TAX EVASION - HOW IT AFFECTS THE ECONOMY WORLDWIDE Tax evasion refers to the process or system by which individuals, partnerships, corporations, trusts, and other entities try to evade payment of taxes through unlawful or illegal means. It is inherent in every human being to resist payment of taxes despite the knowledge that it is a civil obligation of every citizen. Without taxes, the government cannot deliver even the basic services it owes to the people. It cannot construct the necessary structures to develop the country. It cannot build schools, hospitals, and all other government buildings where services are rendered to the people. The Congress, the White House, and the Supreme Court cannot meet and do their businesses. As it is, taxes are the lifeblood of every government. However, people continuously exert their best efforts to evade taxes. They pursue different avenues in order to minimize, if not entirely avoid payment of taxes. Different styles or strategies have been used in order to attain this end. One, underreporting of incomes - usually, this strategy is being used by businesses, whether sole proprietorship, partnership, or corporation. This of course cannot be attained without the assistance of the accountants. The latter manipulate the income to be reported by the business so that liability for taxes would be lesser. In some countries, double numbering of official receipts are made so that only half of the transactions are officially entered into the entry book of the company. Only those transactions which involve important personalities or companies are being recorded officially so that in case of emergency examination of books, the said transactions can be easily traced. Those involving small transactions with not so familiar customers remain unrecorded, or will be recorded only in the unofficial record. Two, overstating deductions and exemptions - again, these cannot be done without the faithful assistance of the so-called accountants who creatively emphasize items of deduction and exempted transactions from the profit or income. Others are so enterprising that they take time to establish allegedly non-government organizations which are of course tax-exempt. Thru the latter, they conduct businesses without the threat of tax liabilities. The otherwise regular businesses are done with a claim that they are being made for some philanthropic objectives. Three, failure to file the necessary returns - this results to absolutely tax-free transactions. Underground economy plays a big role in this strategy. With absolutely no permits and licenses, those engaged in this enjoy the tax-free business as long as they are not caught by the authorities. Despite the fact that their income/capital involves only a small amount of money as compared to the legitimate businesses, if summed up, theirs will constitute a big portion of the revenues that the government could otherwise have received. Tax evasion plays a very important role in the economy. First, it definitely reduces the tax collections of the government, resulting to gross reduction of the public services that the government could have rendered to its constituents as the government should make do with its available resources. Second, it modifies the distribution of wealth in the society. Businessmen indulged in the same line of business would be on unequal footing since the tax-compliant ones have to shoulder additional expense for the payment of taxes while the tax evaders continue to enjoy their profits without entailing the same or similar expense. Third, it impinges on the accuracy of macroeconomic statistics. The tendency to commit tax evasion is caused by many factors, among them are: 1) high tax rates - the higher the taxes to be paid, the more likely the taxpayers would evade its payment as the same would greatly affect their finances; 2) minimal penalties - tax evaders are not afraid of the penalties in case they get caught since most of the time, penalties are limited to civil ones and tax evasion is not usually considered a crime that could lead to imprisonment of entrepreneurs. Indeed, the amount of penalty has a critical effect on tax evasion; 3) soft implementation of tax laws - in addition to the minimal penalties prescribed by tax laws of most states, the government authorities seem to be lax in its implementation, thereby leaving tax evaders unpunished and free; 4) lack of services and infrastructure - the public becomes hesitant to contribute to the government fund if they do not receive expected public services and if they do not see any relevant construction that would otherwise serve as a sign of development; 5) lack of trust in the government authorities - if the people lose their trust in the state leaders, they no longer want to support the entire government, albeit financially; 6) complex tax laws - the more complex the tax laws of a state, the more likely that the accountants could find ways to evade or reduce the taxes of their clients; 7) constant grant of tax amnesties - people would rather make use of the money intended for taxes in the meantime and just wait for declaration of tax amnesties later. This creates a presumption on the part of the taxpayers that the government is always willing to receive smaller revenues rather than none at all. According to Americans for Fair Taxation, although forty percent of Americans do not pay income taxes, the reasons for non-compliance are quite unintentional: (1) taxpayers lack the requisite knowledge of the tax law that even tax lawyers cannot grasp the entire tax code; (2) taxpayers interpret the law differently; (3) taxpayers lack record-keeping ability sufficient to satisfy the tax authorities; (4) taxpayers do their math wrong, or they rely on professional return preparers who get it wrong. All governments have created different policies in order to minimize, if not entirely avoid, tax evasion in their respective countries. In China for example, the government plans to increase supervision on tax sources of overseas-fund companies. Some of these companies transfer funds thru subsidiaries in order to evade taxes. Earlier, the Chinese government required companies to report taxes themselves, then conduct tax assessment and then occasionally conduct spot checks. They said that tax assessment plays a vital role in enhancing the tax collection system. By conducting a preliminary assessment on accounting records brought by taxpayers before tax inspectors go looking for fraud, tax authorities can keep close watch on tax sources and distinguish between tax evading and honest mistakes in the preparation of accounting records. The enticement of maximizing profits lead some overseas-funded companies to ignore some tax requirements when they learn that the cost of evading taxes is lower than the benefit of paying taxes. In the United States, Connecticut Representative Nancy Johnson and Massachusetts Representative Richard Neal legislated for an increase in taxes on banks with offshore licenses which are viewed as competitors. Most American legislators prefer the punitive style of approach in tax law implementation rather than serve as tax havens which their counterpart in third world countries do to attract foreign investors. They have accepted the fact that Americans prefer profits rather than patriotism so much so that they rather keep their money than to give government revenues to support government expenditures. Senator Charles Grassley of Iowa proposes barring tax haven to corporations from entering into contracts with the U.S. government. He even encouraged the Americans to boycott the products of these companies as they allegedly do not contribute to the America's sinking fund. The United States also implemented various tax policies such as Controlled Foreign Corporation taxation, otherwise known as the anti-tax haven taxation. Under this system, the principle of corporate taxation is applied. The domestic companies are taxed based on its worldwide income, and not just on its domestic income. Thus, those domestic parent companies which has foreign subsidiaries that maintains its undistributed income in another country where taxes are substantially lower can no longer hide its total income as the parent company will now be taxed fully. Another policy that it has implemented is the transfer pricing taxation. This aims for the prevention of possible transfer of income to countries with low tax impositions through the conduct of transactions between related parties under conditions that are entirely different from independent parties. Through this scheme, the United States keeps its taxation rights secure. Another policy is the thin capitalization wherein dividends are not deductible from the taxable income of the company while interest in loans are deductible. Its objective is to prevent deduction of excessive interest payment by an overseas-funded company to its foreign parent company beyond certain limits In Asia, the People's Daily Online reported that the Chinese and Japanese tax administrations recently signed Bilateral Advance Pricing Agreement in Beijing to start their cooperation on fighting against tax evasion. This was intended to facilitate the information exchanges on products and labor between the two countries in order to prevent tax evasion strategies by businesses. In Canada, the government entered into around 60 tax treaties that set out a structure for taxes on investment income flowing between Canada and other countries. More so, they provide a device to avoid double taxation and prevent tax evasion. In United Kingdom, the government prepared a plan wherein people with savings outside their countries will have to pay some form of tax to their home governments; however, it was criticized based on the claim that wealthy people will still find a way to evade taxes if they have discretionary trusts, thereby avoiding such requirement by the government. Trustees who handle the individuals' assets can establish companies that are not required to pay taxes. These companies can then open bank accounts and then issue dividends to the trustees for distribution to beneficiaries. The dividends, unlike interest payments, do not fall within the abovementioned plan. The UK inland revenue are now preparing some rules that will apply to UK trusts and partnerships that will help counter any tax avoidance devices. It claims that it has information powers that can be used to investigate trusts, and the information obtained can be exchanged with other countries with which it has established tax treaties. Meanwhile, new tax regulations now rely on either tax authorities in member states exchanging information, or countries hosting financial records which impose a withholding tax on interest accumulated on savings. Another way that was devised by the states is through the improvement of cross-border exchange of information as intimidated earlier. In these times wherein trade liberalization and financial markets continuously progress gradually, taxpayers' opportunity to evade tax payments in international level also increased. Fiscal borders become a hindrance to implementation of tax laws. Tax authorities cannot just impose taxes without credible financial information of the taxpayer's income-producing activities in or out of the country. Domestic sources of information are not adequate to determine exact taxes for cross-border transactions. It is an undeniable fact that most countries protect the confidentiality of financial information of its constituents. It therefore prevents tax authorities from other states from imposing the proper taxes owed to them by individuals abroad. In addition, even if there exists bilateral treaties relating to exchange of tax information of two countries, their scope are usually limited to direct tax matters like income taxes. Other income-producing activities or transactions are left out. Hence, the Organization for Economic Cooperation and Development has introduced a mode wherein tax authorities of different jurisdictions are permitted to exchange information that are relevant to tax collection. It has now more than two hundred twenty-five treaties concluded between member states. As laid down in OECD Observer, there are three major ways by which countries can exchange information. First, under the Model Convention and the OECD Council of Europe Convention, the requesting country should be willing to give tax/income information from its jurisdiction before making a request to a treaty partner or member. The information asked should be precise and specific. Requests based on mere speculations and without any justification are prohibited and cannot be granted. Second is the automatic exchange or sharing of information such as the periodic payments, interest and dividends paid to non-residents that might be taxable in the taxpayer's home country. This does not only benefit the treaty members/partners but also the taxpayers themselves since they can clearly avoid double taxation. Third is the spontaneous exchange of information wherein the taxing authority of one country automatically gives details or information that it presumes could be of help to the other member country. These however are limited by the fact that each member country must comply with its own internal rules on disclosure. Hence, if a member country observe stringent rules, it cannot and will not help the other members in any way. Thus, lack of reciprocity would alter the very motive behind the treaties. It was suggested that in order to do away with this kind of problem, member countries should re-evaluate its domestic rules prior to signing of the tax treaty. If a member country gives very limited information on the taxpayers, the same will also prevent them from receiving further information from other member countries with liberal disclosure rules. It was also suggested that transparency in corporate ownership be encouraged so that the tax evaders would have a hard time doing their illegal activities. Commercial secrecy should now be eliminated. Furthermore, new technology should be used in order to enhance the exchange of communication between member countries. If these improvements are not seriously given attention, governments around the world would all suffer adverse consequences due to failure to collect proper taxes. At the outset, it will be directly affected by the loss of revenues that finance its services to the public. In the long run, investors might later on transfer to other tax-friendly countries since taxpayers who comply with their tax obligations will be unduly burdened by continuously increasing tax impositions whenever these governments suffer deficit in budget due to uncollected taxes. CONCLUSION It is quite frustrating to note that countries all over the world have devised different ways and means in order to collect the proper taxes from their constituents. Millions of money have been wasted in conventions, studies and researches, just to find the most effective way of cornering the taxpayers, whether individual or business entities, and force them to pay their taxes which they owe to the very governments which protect their respective businesses. The tax evaders seem to be unaware of their legal and social obligation to support the institutions which otherwise helped them put up their businesses and improve the facilities, structures, and all sorts of development that further enhance their delivery of products and services to their respective clients or customers. In fact, they need not even be reminded, much more forced, to pay the same. They should see tax payments as expenses that are necessary to bring about profit or gain. If taxpayers have been paying their proper taxes without need of compulsion, the governments could have saved millions per fiscal year in pursuing tax evaders, conducting investigations, filing of tax cases. These same money could have been used to build bridges, roads, schools, and other infrastructures, provide hospital equipments, feed the people from marginal lines, etc. Despite the continuing increase in penalties and strict reporting requirements, tax evasion has increased by more or less 67% in United States. As a percentage of Gross Domestic Product (GDP), tax evasion has reached 2.0 percent in 1992 as compared to 1.6 percent in 1981 and it continuously amount to approximately 22 to 23 percent of all collected income taxes. These figures do not even include the taxes which are lost due to illegal sources of income. These accounts only for the United States. If we add up all the lost revenues around the world, the figures might be astonishing. They could even build communities and saved lives of millions of people. If the facts are not enough, tax evaders just have to look at their surroundings. Whatever they feel is lacking in their countries, they could have been completed if they paid the right amount of taxes. Indeed, world development relies heavily on the stoppage and prevention of tax evasion. It is high time now to consider and reflect the vast consequences of this irresponsible act of tax evading. The concern is no longer limited to individual interest; rather, it involves the whole humanity. WORKS CITED: Alm, James. "Tax Evasion" The Encyclopedia of Taxation and Tax Policy. Urban Institute Press The Bermuda Tax Triangle," Editorial, The New York Times, May 13, 2002, p. A18 http://www.urban.org/pubs/taxation/alm.html Retrieved 18 May 2006. http://www1.oecd.org/publications/observer/215/e-perez.htm Retrieved 18 May 2006 http://www.mofa.go.jp/policy/economy/summit/1999/g7state.html Retrieved 18 May 2006 http://www.focolare.org/en/sif/2000/20000921e b.html Retrieved 18 May 2006 http://www.mof.go.jp/english/if/vmi021106e.htm Retrieved 18 May 2006 http://www.globalissues.org/TradeRelated/Corporations/Evasion.asp Retrieved 18 May 2006 http://en.wikipedia.org/wiki/Tax Retrieved 18 May 2006 http://www.econ.queensu.ca/faculty/boadway/evasion-august-03.pdf Retrieved 19 May 2006 Read More