A recent paper by John Guyton, Patrick Langetieg, Daniel Reck, Max Risch, and Gabriel Zucman finds that previous IRS estimates of income misreporting at the top of the individual income distribution are understated. By a lot. In other words, the paper finds that rich people cheat on their taxes much more than we used to think. Random audits, which are used to detect this cheating, are less accurate for rich people than poor people, as the rich are able to use tax evasion techniques that are particularly difficult to find upon audit (holding asserts in difficult-to-discover entities in countries with low disclosure). I thought this was an interesting and useful paper. I won’t dive into any details here. But, as someone who thinks a lot about corporate income, given this paper, the question becomes, how should I think about IRS estimates of non-compliance for large corporations?
I don’t personally think the estimates will suffer from the same problem as for private individuals. The very, very largest corporations are frequently public corporations, which undergo mandatory audits every year by financial statement auditors. Rather than relying on an underfunded IRS, these auditors are paid by the public company, and, I think the general perception is they audits are done well. Public firms derive benefits from having high earnings, and high assets, that are publically disclosed to investors (which result in high share price). For these assets to be disclosed, they have to be audited by financial statement auditors. They can’t simply be concealed.
Large corporations, to be clear, do a great deal of tax planning, some of which ends up being determined to be illegal. But, in my opinion, it is an entirely different type of tax dealing. A shady wealthy individual will simply put assets in a foreign jurisdiction where the IRS cannot see the assets, or the income generated. The individual then finds sneaky ways to consume, or pass down, those accumulated assets. End of story. A large corporation employs an army of accountants, lawyers, and transferring pricing economists to determine plausibly-but-not-certainly legal ways to shift assets to foreign jurisdictions at low transfer prices, then charge a high-tax parent royalties for their ongoing use. Or any other number of planning techniques, all of which the IRS is aware of, and, if better funded, might pursue, but which are costly to pursue, exactly because they are plausibly-by-not-certainly legal, and, have the backing of fancy lawyers and accountants stating they are plausibly-by-not-certainly legal. And, most are actually legal (but sorting the legal from the not is, again, very hard)!
To be clear, wealthy individuals do play some of the same games, and, private corporations could simply be concealing assets. And, for sure, a very rare public corporation might simply try to conceal assets. But, most tax planning done by large, publically held firms is of the type that only after much IRS effort, potential trials, etc., can anything be determined to be illegal, and, in those cases, often because a judge determined it was just slightly too far into the grey zone to be permissible. As a result, I would put more trust into the estimates of public firms’ tax under-reporting than I would wealthy individuals under-reporting.
