America’s unreported economy: measuring the size, growth and determinants of income tax evasion in the U.S.

Abstract

This study empirically investigates the extent of noncompliance with the tax code and examines the determinants of federal income tax evasion in the U.S. Employing a refined version of Feige's (1986; General Currency Ratio (GCR) model to estimate a time series of unreported income as our measure of tax evasion, we find that 18-23 % of total reportable income may not properly be reported to the IRS. This gives rise to a 2009 "tax gap" in the range of $390-$537 billion. As regards the determinants of tax noncompliance, we find that federal income tax evasion is an increasing function of the average effective federal income tax rate, the unemployment rate, the nominal interest rate, and per capita real GDP, and a decreasing function of the IRS audit rate. Despite important refinements of the traditional currency ratio approach for estimating the aggregate size and growth of unreported economies, we conclude that the sensitivity of the results to different benchmarks, imperfect data sources and alternative specifying assumptions precludes obtaining results of sufficient accuracy and reliability to serve as effective policy guides.

The use of Expected Utility Theory (EUT) in Taxpayers' Behaviour Modelling

“…the result obtained by Yitzhaki shows that tax fraud decrease when the tax rate increase. But empirical literature (Cebula and Feige, 2011) shows that there is a positive relationship between tax rate and tax fraud.…”

“…Several researches consider that such result disagree with the intuition; it was called the "Yitzhaki paradox". An empirical literature (Cebula and Feige, 2011) reveals that there is a positive relationship between tax rate and tax fraud. Kahneman and Tversky (1979) developed a new theory called the Prospect theory based on experimental work.…”

A methodology for determining the ‘cash economy’ in the European Union via an announcement effect

“…Whilst some of the missing dollars can be found in the process of 'dollarization' (overseas holdings of dollars as a hard currency) the 'new' figure reported above is a domestic one being net of this 'dollarization' sum which the author calculates has been significantly overestimated in the past. In responding to some of the criticisms of Feige's (1989) general currency ratio model Cebula and Feige (2012) use Feige's new estimates of domestic US currency holding in estimating that some 18-19% of US total reportable income goes unreported. It is the idea of making 'missing dollars' or more generally 'missing cash' visible and measurable that motivates the remainder of this paper.…”

New estimates of U.S. currency abroad, the domestic money supply and the unreported economy

“…As described in greater detail in Cebula and Feige (2012), we refine the restrictive GCR model by relaxing some of its key assumptions. First we substitute our estimate of domestic currency in circulation (C dom ) for the total amount of currency in circulation (C) since currency held abroad does not reflect tax evasion activity in the U.S. Second we account for a major technological innovation in the financial industry (the introduction of sweep accounts) which reduced the volume of "checkable deposits" (D) in a manner totally unrelated to behavior in the unreported economy.…”

“…First we substitute our estimate of domestic currency in circulation (C dom ) for the total amount of currency in circulation (C) since currency held abroad does not reflect tax evasion activity in the U.S. Second we account for a major technological innovation in the financial industry (the introduction of sweep accounts) which reduced the volume of "checkable deposits" (D) in a manner totally unrelated to behavior in the unreported economy. Figure 10 displays the effects of these two adjustments by comparing the conventional C/D ratio employed in many published estimates of the "underground" 26 As described in Feige (1989) and Cebula and Feige (2012) these restrictions imply that the ratio of unreported income (Yu) to reported income( Yo) can be estimated as follows: Yu/Yo =(C-koD)/ (ko+1) D: where C = Currency, D= Checkable deposits and ko= (Co/Do), the currency deposit ratio in the official economy which is observed in the year (1940) 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Figure 10 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 unreported income amounted to $1.9 -2.4 trillion, giving rise to a tax gap of roughly $400-$550 billion. While these estimates relax several of the key assumptions usually associated with the currency demand approach, they remain quite sensitive to alternative specifying assumptions.…”