The Taxation of Concealed Offshore Wealth: Evidence from US Enforcement and Implications for Inequality

Income and wealth inequality are on the rise in the US, the UK and some European countries. Concerns over growing inequality have led to renewed public interest in the use of progressive tax policy to curtail it. In practice, however, one key factor limits the ability of modern governments from taxing very high-income, high-wealth individuals: the use of offshore wealth to evade taxes. What evidence we have suggests that a significant share of the income and wealth earned by individuals at the top of the income and wealth distributions accrues to concealed offshore accounts, where it generally goes untaxed.

This project studies two serious problems created by the use of offshore wealth to evade tax. The first problem is a direct policy challenge: how can countries tax income derived from offshore wealth, given that it is difficult to detect? The second problem is an academic problem with downstream policy consequences: just how much tax evasion is there at the top of the distribution, and how does this affect our measures of inequality?

This research project will answer these two questions using administrative data from the United States Internal Revenue Service (IRS). The US is the ideal setting to study these questions because it is a wealthy country, and because the US recently implemented increasingly aggressive policies targeting offshore wealth. Starting in 2009, the US used virtually every tool at its disposal, including lawsuits, prosecutions based on data from whistleblowers, and, most importantly, the passage of new legislation. The Foreign Accounts Tax Compliance Act, implemented starting in 2012, now requires that financial institutions outside the US report to US authorities on Americans' wealth held at those institutions and the associated income. Examining the impact of these policies will help us understand whether tax enforcement targeting offshore wealth can be effective, and the data generated via the implementation of the policies can provide unparalleled insights on the importance of offshore wealth for the measurement of inequality.

The first part of the project is to use data to examine the impact of enforcement on tax evasion. We begin with very simple aggregate data analysis, showing how the reporting of offshore wealth and income has evolved over time. Preliminary results suggest that enforcement had an extremely strong effect on reporting, which is visible in simple aggregate data. We will then use causal microeconometric research designs to understand whether patterns in aggregate data are attributable to enforcement, and to estimate the total impact of the policy along several dimensions. We will estimate how the overall impact of enforcement varies by the location of wealth, by owners' rank in the income distribution, and by the method of holding of assets - directly or through shell corporations. Together, this should provide a detailed overview of the impact of the reform, which is an important input into the ongoing and controversial debate over these enforcement policies.

The second part asks what we can learn about tax evasion and inequality from new data on offshore wealth. Most measures of inequality, such as top 1% income shares, are estimated using data from individual income tax returns. If people evade income taxes by concealing their wealth, some income never appears on tax returns, biasing estimates of top income shares. Simultaneously, the random audits conventionally used for research on the extent of evasion virtually never detect concealed offshore wealth. We will combine a wide array data on offshore tax evasion in the US with conventional data on evasion from audits of a random sample of individuals. We will estimate the extent of evasion throughout the income and wealth distributions, and estimate top income and wealth shares that correct for offshore evasion. Such distributional statistics are vitally important for the debate over inequality.

The proposed research will have broad impact, not only in academia but also for several government agencies, legislators, and the general public.

Academic beneficiaries are detailed earlier in the proposal.

Government agencies:
The most direct beneficiary is the Internal Revenue Service. As it is chronically understaffed, the IRS increasingly relies on outside researchers to help develop its internal data resources and strategy. Our work will build datasets at IRS that can be used for further tax administrative problems. The results of our research will help to inform IRS strategy going forward regarding how best to pursue non-compliant owners of offshore wealth. This is not speculation: I have seen strong indications that my prior work on offshore accounts has already had an influence on IRS strategy, and the leadership at IRS has expressed keen interest in having us do more research on these topics. Beyond the IRS, a number of other agencies, including the US Treasury, the OECD, and tax authorities in several countries have expressed keen interest in the findings of my prior work, on the impact of FATCA, and more broadly on offshore wealth and the implications for measuring inequality and tax compliance strategy.

Legislators and policymakers:
The Foreign Accounts Tax Compliance Act is the subject of much controversy and criticism, and was even strongly considered for repeal in the recent US tax reform (the repeal was ultimately abandoned). Critics of the policy point to privacy concerns, unintended consequences for expats, and the compliance costs imposed on financial institutions. Policymakers therefore need to know whether FATCA had any of its intended benefits, which we know virtually nothing about until this project, to determine whether the costs are worthwhile or how the benefits can be strengthened and the costs mitigated. For policymakers outside the US, the impact of FATCA is a harbinger of things to come from very similar information exchange that will occur under the Common Reporting Standard recently adopted by many countries, including the UK.

The general public:
Public awareness about inequality is arguably at an all-time high at the present moment. This project will provide credible estimates of key facts about the ownership of offshore wealth, the prevalence of tax evasion at the top of the income distribution, and the importance of accounting for offshore wealth in measuring the full extent of income inequality. I expect these findings to generate substantial media coverage and public interest, and ultimately hope that they will lead to a more informed public policy debate about inequality and progressive tax policy.

Pathway:
As in the past, the benefits to government agencies will be pursued by meeting with representatives of these agencies and presenting research and answering their questions internally. I will also continue to present at conferences widely attended by members of such organisations. Regarding outreach to the general public, the Washington Center for Equitable Growth, a Washington DC organisation promoting evidence-based policy with an excellent track record, has already expressed interest in this research and in helping my collaborators and I disseminate the research to policymakers and the media. I will also speak with the excellent LSE Public Affairs office for help disseminating my research to the general public in a variety of ways. I will also make a significant amount of aggregate data generated by the project publicly available on my website.