The visible hand in economics

Avoiding the taxman

Posted on: March 9, 2008

Talking to Agnitio today, he mentioned that the result of having a top personal tax rate above the company tax rate is tax avoidance and evasion. The idea being that people with wealth will try to pipe income through businesses to avoid paying the top tax rate. Well, it seems he’s empirically justified in that view (kinda). According to a study of the Russian flat tax reported on VoxEU, the greatest gains to be made through a flat tax are in reduction of tax evasion:

The adoption of a flat rate income tax is not generally expected to lead to significant increases in tax revenues because labour supplies are believed to be fairly inelastic. However, if an economy is plagued by ubiquitous tax evasion, as was the case in Russia, then a flat rate income tax reform may lead to substantial revenue gains via increased voluntary compliance. At the same time, a strong evasion response suggests that the efficiency gains from the Russian tax reform perhaps are smaller than previously thought.

I don’t think that NZ has tax evasion problems like Russia does, so maybe the revenue gains aren’t there to be made and the efficiency gains are minimal at best. However, there are surely efficiency gains from re-allocating resources away from tax avoidance to be made by reducing the top tax rate.

Note that this doesn’t show that flat taxes or a lowering of the top tax rate is a good idea. To do that one would have to take in to account the social cost of reduced redistribution of income, and the cost of reduced government revenues (if you think they exist).

2 Responses to "Avoiding the taxman"

The graph that I think the RBNZ has of income vs tax with the spike at 60k would indicate there is a more evasion going on than you might think..

I personally would like to earn more and be productive, but faced with a marginal tax rate of 49% (top tax plus student loan) its hardly worth the effort.

A flat(er) tax is fairer and would go along way to improving the productivity of NZ, which would in turn increase tax revenues which you could then redistribute if you felt that was the best way to help the poor, note: it is not in my opinion.

Yeah, IRD data shows definite spikes at 38k and 60k. Plus trust income has been growing rapidly. I don’t think that is strictly tax evasion however (if they could prove it was illegal, IRD would challenge it).

As Mankiw points out, inelastic labour supply doesn’t necessarily mean that “efficiency gains are minimal at best”.

For what it’s worth, I estimate a revenue-neutral flat tax rate to be around 24% (assuming there are no dynamic implications). Which would be a tax increase for anyone earning less than 58,000.

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