Who’s Cheating on Income Tax?
– By Howard Sierer –
The answer to this column’s title question isn’t known, of course: if it was, the IRS would be only too happy to pounce. But it turns out that the answer has a major bearing on a hot button political issue but likely not an issue you’d expect.
Economists studying income inequality would like to know whether high or low income people cheat the most on a percentage basis. If those at one end or the other of the income scale underreport greater percentages of their incomes on their tax returns than those at the other end, then income inequality measures will be distorted.
Income inequality is a political hot button. Is the 1% at the top of the income scale paying it’s fair share of income taxes? Per the IRS, in 2021 they earned 26.3% of all income and paid 45.8% of all federal income taxes – more than the bottom 90% combined – but should they pay more as some legislators argue?
If those with the highest incomes are also those who underreport greater percentages of their income, then they are hiding the fact that their share of all incomes has grown compared with the rest of us. That is, income inequality has grown over the decades and they are using sophisticated tax dodges to hide portions of their income.
Instead, it’s certainly plausible that folks with the lowest reported incomes are more likely to be tax cheats. Many of these folks do service work where they can be paid in cash rather than by check or credit card, jobs like house cleaners, lawn mowers, barbers and hair stylists, and any job where tips are offered in cash.
Those on one side of this argument – in fact the folks who started the income inequality fight in the first place – are economists Thomas Piketty, Emmanuel Saez, and Gabriel Zucman. Their seminal paper on the subject assumes that most of the tax cheating is done by the people who already report a lot of income, for example the venture capitalist who also stashes millions of dollars in an offshore account.
Their initial work was rightly criticized for ignoring government welfare and transfer payments that reduce inequality dramatically. So they republished accounting for these payments and reduced the income inequality they originally reported, but they still came to the same conclusion: income inequality is substantially higher now than it was in 1960.
The opposite conclusion is reached by two authors with surprising day jobs. Gerald Auten works in the U.S. Treasury’s Office of Tax Analysis and David Splinter works as a staffer on Congress’s Joint Committee on Taxation. Given their access and insights into the tax system’s workings, their recent paper has caused a mighty stir among those focused on income inequality.
Their conclusions: “Our analysis of pre-tax income shows that top income shares are lower and have increased less since 1980 than other studies using tax data. In addition, increasing government transfers and tax progressivity have resulted in rising real incomes for all income groups and little change in after-tax top income shares.” In case you missed their carefully chosen words, the “other studies” are the widely-publicized works of Piketty, Saez and Zucman.
They go on: “Our estimates for after-tax income indicate that the top one percent share increased only 1.4 percentage points since 1979 and only 0.2 percentage points since 1962. These improved income measures also have implications for lower-income groups. Instead of real per capita incomes of the bottom half of the distribution appearing unchanged since 1979, we find that after taxes and transfers they increased by two-thirds.”
Piketty, Saez, and Zucman found that the top one percent’s share of after-tax income rose from 9 percent in 1960 to 15 percent in 2019. But, according to Auten and Splinter, the one percent’s share of income has actually remained basically unchanged.
There you have it. If this were an obscure feud between academic economists, it would never reach beyond academia. But this argument rattles around the halls of Congress and results in headline grabbing one-liners from those on the left who pay lip service to closing the budget deficit by “taxing the rich.” Conservatives retort that to make any progress on deficit reduction, Democrats will need either to cut back their huge recently-enacted new spending programs or reach down into the middle class. “That’s where the money is.”
I’ll take Auten and Splinter over leftist economists with a political axe to grind. But the next time you hear or read about income inequality, remember that measuring it requires estimates of unknowable tax cheating data and is subject to controversy.
