Tax Avoidance and evasion Essay

Tax Avoidance and evasion Essay.

Introduction

According to Hyde (2010) tax evasion cost the UK treasury over £15 billion annually. This is approximately 3% of the total tax liabilities that individuals and organisations are meant to pay to the Her Majesty Revenue and Customs (HMRC). While an estimate of £25 billion is lost through tax avoidance annually (Murphy, nd). These are huge sums of money that could go a long way to help the government reduce the national deficit or could have been used for national development projects but have eluded the government.

This report seeks to compare and contrast tax avoidance and evasion. Secondly, critically evaluate the effectiveness of HMRC’s approach to the “tax avoidance industry” in recent times.

Comparison between tax evasion and avoidance

Both tax evasion and avoidance are ways and means that people and organisations use to deny the treasury of the required revenue that they ought to have collected. While in broad terms both activities are wrong and morally questionable, it can be argued that one is legal and the other is a criminal act.

The following are the comparison between tax avoidance and evasion.

Legality

Evasion is the illegal manipulation of business affairs to escape taxation. This is a criminal act that when caught will lead to prosecution. An example could be the directors of family-owned business not declaring cash sales. Another example might be the payment of a low salary (below the threshold of income tax) to a family member not working in the company, thus reducing profits in an attempt to reduce corporation tax (Elliot & Elliot, 2011). In contrast, tax avoidance is sometimes seen as legal especially if the mode of practice used is define by law such as giving gift to your children in such a way to avoid paying an inheritance tax. It can be seen as artificial ways of manipulation one’s affairs, within the law, so as to reduce liability, it is legal and it can be argued that it is not immoral. (Elliott & Elliott, 2011) Some of the means by which individuals avoid tax payments are; a. Shifting income from a person with higher rate tax payer to a basic rate tax payer b.

Moving transactions out of the UK to tax heavens such as Switzerland. c. changing the nature of transactions, in particular so that income tax is subject to Capital Gains Tax rather than income tax d. Tax abusing the law on limited companies (Murphy nd p3). Even though tax avoidance is legal, the HMRC have statutory powers under the tax law (“anti-avoidance”) provisions to stop organisations from designing tax avoidance schemes which may be seen as a gross exploitation of loopholes in the tax system. Example of this scenario is when HMRC asked Barclays bank to pay £500 million of tax avoidance recently and also stopped them from designing and using two schemes that were intended to avoid substantial amounts of tax (BBC, 2012)

Morality

Both means of avoiding the required tax payment is immoral. Even though tax avoidance can be seen to be legal it is still immoral. This is because, it is seen as a clever means of dodging one’s civic responsibilities. Murphy (nd) argues that only the few rich people and companies in society, who can afford the services of expensive accountants and legal advisers, are involved in tax avoidance schemes. This sounds unfair as it prevents the chancellor from creating a fairer tax system that will help the majority of the population (lower and middle class). HMRC Approach to the “tax avoidance industry”

The following are some of the strategies that HMRC is using to combat the tax avoidance industry Making tax law robust against avoidance
This is one of the governments excuse for scrapping the 50% (50p) income tax for people earning income of £150,000 per annum to 45% by next year. This is because it is estimated that there is a drop in tax collection of £20 billion as the total declared taxable income of those earning more than £150,000 a year slumped from £116 billion in 2009-10, to £87 billion in 2010-11 (Pollock, 2012). Engaging with customers about approach to avoidance

According to the BBC (2012), under the banking code on taxation, the banks that signed have commitment themselves not to engage in tax avoidance scheme, therefore, anyone such as a bank, accountant, lawyer or tax adviser, who devises a seemingly legal tax avoidance plan, is obliged to tell the tax authorities about it within a few days of using it or marketing it to clients. This is a good way by which the HMRC is working hand-in-hand with their customers to prevent avoidance. This system will only work if the customers are willing to disclose the loophole to HMRC.

Conclusion

The HMRC looses an estimated sum of £40 billion annually through tax evasion and avoidance. Tax evasion is a criminal act which perpetrators can face prosecution for it, while tax avoidance can be seen as using the loopholes in the tax law to avoid paying the right amount of tax required. HMRC are using the following strategies to tackling the problem of tax avoidance; making tax law robust against avoidance and engaging with customers on to seal any loophole in the tax avoidance industry.

* Part B:Inheritance tax
* 1 Introduction

Inheritance tax (IHT) can be defined as the tax that is paid on ones estate after death on condition that his/her estate is valued in excess of £325,000. IHT is chargeable to an individual who is domiciled in the UK. It is chargeable in relation to all his/her property situated throughout the world. An individual who is not domiciled in the UK is liable to IHT only in relation to property situated in the UK. (Melville A, 2012).

Arguably there are implicit sentiments of unfairness with the payment of this tax. This can be based on the argument that the deceased has already paid tax on the income that he used to acquire the estate, hence charging tax on the estate again can be construed as ‘double taxing’. To this end, many commentators believe that inheritance tax can be avoided altogether through careful planning.

This report discusses the planning measures that a tax payer can take to avoid or mitigate IHT liabilities and evaluate the likely success of such strategies. The report will also outline any effect that this planning measure will have on the taxpayer’s liability under any other tax. * 2Tax planning measures that mitigate IHT liabilities

There are different ways by which payment of IHT can be either mitigated or avoided entirely through planning. Some of these measures are as follows; *

2.1Asset Reduction

This involves reducing the value of the asset through immediate lifetime gifts to family members, charities, political parties, state institutions such as the national museum among others. According to Mckie and Mckie (2010), the following are some of the means by which the value of the asset can be reduced. a. Spouse – Assets can be transferred to spouse whether during lifetime or on death. There is no cap on how much can be transferred to partners living in the UK. However, there is a cap of £55,000 for partners that are not domicile in UK.

b. Annual exemption on gifts- One can give gifts up to £3,000 in any tax year. Any unused allowance from the immediate previous year can be carried forward. Small gifts up to £250 per person in each tax year. c. A marriage gift to the value of £5000 from each parent of a couple getting married is exempted from IHT. This is extended to grand children who are getting married but to the value of £2,500. Anyone else can give £1,000. *

2.2Potentially exempt transfers (PETs):

These are gifts that do not immediately come under the tax-free gifts but could become tax free in future. An asset transferred to either family member or organisation under PET is only exempted if the donor lives for seven years after making the donation. However, if the donor passes way within seven years, the asset becomes a chargeable transfer and the person who received the PET will be asked to pay 40% IHT on it. The amount of tax is calculated using taper relief according to citywire [online]. This means that the older the gift, the larger the reduction in tax. * 2.3Alternative Investment Market (AIM) shares

These are investments that can be made throughout one’s lifetime that will be exempted from IHT when the investor dies. Some of the companies whose shares fall under the AIM, which qualify for an IHT exemption are available at the junior wing of the London Stock Exchange. The investor holds the unquoted shares minimum of two years, they will be considered as business property and will be eligible for business property relief at 100%. This means that they fall outside of the investor’s estate portfolio for IHT purposes.

Tax Avoidance and evasion Essay

Tax Incident Essay

Tax Incident Essay.

Government generally collect taxes to generate revenue and question arise here is that after imposition of taxation, which group will bear the tax burden. After implementation of tax, there would be the division of tax burden between byres and sellers which is known as tax incidence. Tax incidence is linked to the price elasticity of demand and supply.

If supply is more elastic than demand then the tax burden falls upon the buyers and when the demand is more elastic than supply then the producers will bear the cost of the tax.

Tax incidence is basically the analysis of the effect of taxation on the distribution of economic welfare. Tax incidence expose that which group either consumer or producer is going to pay the price of new tax and it falls mostly on the group that has the inelastic price quantity or respond least to the price. Tax incidence or the tax burden does not depend on that where the revenue is collected but it depends upon the elasticity of demand and supply. The purpose of this review on the literature is that to analyze the effect of particular tax on the distribution of economic welfare. Section 2 is related to the literature review and section 3 is related to the conclusion.

2. Review of Literature

2.1 The incidence of sin taxes:

Kotakorpi (2008) has examined the incidence of taxation on sin commodities. Sin commodities are those commodities whose current consumption causes utility cost in the future. Consumers are considered to be time inconsistent or having too much consumption of unhealthy goods. Sin taxes means taxes on unhealthy commodities. In the context of monetary cost sin taxes would lead to influence the individual’s utility. Increase in the consumption of sin commodities would lead to a higher monetary cost or higher utility benefit from self controlling. The author has analyzed the welfare effect of the sin taxes and the welfare effect of sin taxes depends upon the elasticity of demand. The individuals with less income group having higher elasticity of demand as compare to the high income group. There is possibility of progressive taxation as the benefit is high for the less income group. He has measure the incidence on individual utility through the overall impact of the tax.

Sin taxes would lead to increase the welfare if the demand for the unhealthy good is more elastic. For the case of poor demand is more elastic so the burden of sin taxes falls least on the poor as compare to the rich. It’s not necessary that taxation always hurts low income group but can be fair for the poor. The welfare of the economy would increases in case of sin taxes. 2.2 The incidence of tax on pure rent in a small open economy: Petrucci (2006) has investigate the effects of a land tax on capital structure and foreign investment in a life cycle small open economy with the assumption that labor supply is take as endogenous. Land is an as asset which is used as an input for the production.

Tax on land means the higher would be the capital stock. The land tax leads to reduce the price of land but crowds out investment, consumption and welfare of nationals would increase. The consequences of land taxation depends upon that how government adopted the tax transfer program. Labor supply and domestic output reduced by land taxation, while the wealth and national income are increased. If land taxation were used to finance the un-productive government expenditure then the effects of taxation on the capital stock and aggregate wealth would be neutral. The main assumption of this article is the endogenous labor supply regarding the long run incidence of taxes. The final effects of land taxation on economic growth and wealth formation depend upon that the government tax transfer program. When tax revenues are distributed as lump-sum payments then the land taxation increases consumption and stimulate wealth but leads to reduce the capital stock.

2.3 Tax incidence in bargaining:

Chae (2002) has investigates two-person bargaining model where one party is taxed and the other is non-taxed party who shares the burden of taxes. Sufficient condition is that tax party would entirely bears the tax burden are given and non-tax party would actually to benefit from taxation is given. In a competitive market, buyers and sellers share the tax burden and the larger burden falling on the party that has lower price elasticity. In a bargaining model, if the gross revenue of the tax party does not change then the taxation does not affect the other party. Thus the tax burden will falls completely on tax party. If the tax party is risk neutral and has zero opportunity cost then the burden of taxation falls completely on the tax party. If the tax party is risk averse with the constant relative risk aversion, then the tax burden is shared by the non-tax party as initial wealth is also positive. The results show here that a risk loving party loses more form taxation than the risk averse party.

In general, a bargaining party that is less risk averse has more bargaining power but the party with more bargaining power can also be more at risk to taxation. 2.4 The general equilibrium incidence of environmental taxes: Fullertton (2007) used a simple general equilibrium with pollution and has found the incidence of pollution tax on prices of outputs and on the returns to inputs. When both sectors are equally capital intensive and capital is a better substitute for pollution then is labor. Then return to capital would rise comparative to wage. These results provide evidence that the substitutability of capital and labor has very important consequences for environmental policy. The results show that a 10% increase in the pollution tax rate reduces pollution from 2% to 10%.

The model in this paper provides theoretical analysis of the incidence and distributional effects of environmental policy. It shows that how differential substitution between factors greatly effect the burdens of a pollution tax. Environmental taxation has mostly focused on efficiency effects. This paper provides theoretical general equilibrium model of tax incidence of an environmental tax that allows for general forms of substitution among inputs of labor, capital and pollution. Pollution is modeled as an input along with capital and labor. Environmental policies can have important effects on firms’ demands for capital and labor inputs, which can impact the returns to owners of capital and labor in general equilibrium.

2.5 The tax system incidence on unemployment: A country specific analysis for the OECD economies: Ramon et.al (2008) examines the incidence of different tax structure on unemployment in OECD countries through wage bargaining model. The first important result from the analysis is that fiscal wedge does not play an important role in explaining unemployment. The more the payroll taxes are influenced towards the employees, the higher would be the unemployment. This is due to the higher elasticity of taxes impose on workers so that tax components affect unemployment even when the overall fiscal wedge remains unchanged.

As unemployment determination is considered, supply side determinants (productivity growth) positively related to the unemployment determination but negatively related with demand side determinants (inflation). This suggests that high situation of unemployment persistence may tend to require more structural reforms. If changes in the tax composition that leave the overall amount of revenues unchanged are harmless in terms of unemployment persistence then new possibilities for policy makers can be considered.

2.6 Tax and subsidy incidence equivalence theories: experimental evidence from competitive markets: Ruffle (2005) stated that tax burden does not depend upon that where revenue is collected but the division of tax burden between buyers and sellers only depend upon the elasticity of supply and demand. The theory of tax incidence equivalence is strongly related to the market formation and also enlarges to the subsidies. The benefit of the subsidy is not related to the one that who is in fact getting the subsidy.

Basically, government should charge tax to decrease the agreement costs and it should not to leave the restrictive producers at disadvantages. In the competitive equilibrium market, particular shifts of supply and demand curves are considered to analyze the tax and subsidy equivalence theorems. Both the smaller no of markets and sufficiently large no of markets can trade profitably at the competitive price. The results propose that the discussion topic is that who is paying the tax or receiving the subsidy should pay attention on formation that at what degree market is under the competition level. And if the market is competitive then the tax should be manage in a manner that reduces the expenditure cost.

2.7 Tax incidence under oligopoly: a comparison of policy approaches: Hamilton (1999) examined the tax incidence under the oligopolistic market structure. Basically two forms of commodity taxation considered are the unit (or specific) tax and sales (or ad valorem) tax. The author has incorporated the shift parameters in a generalized tax schedule to analyze the incidence of taxation under oligopoly. Greater industry output and increased output per firm is associated with output elastic schedule.

If there is a case of free entry in oligopoly then there would be the larger reduction in industry fix cost relative to the tax schedule that is less responsive to the equilibrium level of output. Taxation under oligopoly, benefit would be increased with revenue neutral reforms to relatively output elastic tax plan. The results of other studies show that with specific or ad valorem taxation leads to efficiency loss in oligopolistic industries with a fix number of firms. Degressive taxes with both specific tax and ad volarem tax leads to efficiency gain, when the tax output is elastic enough.

2.8 The incidence of income tax on wages and labour supply:

Bingley and lanot (2002) has analyzed the determination of equilibrium and labor supply in the presence of income taxes. They found the strong evidence of fractional shifting of income tax from worker to employer. As tax is not fully shifted if the income tax is incident on equilibrium wage. There is not shifting of burden of taxation as labor supply response to wages is measured. And the labor supply elasticity with respect to wage is very small after income taxation. Higher income tax leads to a higher employment. In the article, the author showed the effect of income tax on gross wages and labor supply wage elasticity.

The incidence of taxation on gross earnings is a mix of labor supply and gross wage responses. In this model the author has chosen the Denmark country. In Denmark, income tax varies regionally as workers pay tax according to where they live rather than where they work. The result shows that the, in Denmark, gross earnings bear less than the full burden of labor taxation and gross wages bear proportionately more of that tax burden. The results shows, by ignoring the labor supply response to a tax change may lead to a wrong conclusion that the tax is fully incident on equilibrium earnings.

2.9 The incidence of personal income taxation: evidence from the tax reform act of 1986: D. kubik (2004) examined in this paper about the short run incidence of personal income taxation in US by analyzing that how wage structure shifted after the tax reform act of 1986. In this analyses pre tax wages and income of workers are endogenously determined through tax policy. Workers of an economy with different skills, the pre tax wage of each skill depend upon the quantity of labor supplied. Basically, the purpose of the paper is that whether changes in personal income tax affect the US wage formation through the evidence from the tax reform act of 1986. Firstly, the author has tested that how marginal tax rate of the median worker in each occupation changed due to the tax reform and then tested the wages of workers in each occupation before and after 1986.

Personal income taxation changes through the tax reform act of 1986 have affected the wage distribution and results shows that the legislation has lowered the marginal tax rate of high income individuals but low income individuals relatively unaffected. If the training and potential earnings of the people are quite similar then the tax reform act of 1986 will affected the people in the same way. High skill workers in a profession earns high incomes leads to a sharp decline in marginal tax rate but on the other hand low income individuals faced minor changes in marginal tax rate. The result depends on the assumption that labor supply decisions are affected by the marginal tax rate. Labor supply decision changes as individuals change their work hour decision or can cause a worker to drop the profession. Wage rate were affected by the shifts of workers supply in the labor market due to the tax reform 1986.

2.10 Tax incidence when individuals are time-inconsistent: the case of cigarette excise tax: Gruber and Koszegi (2004) stated that lower income groups consume much of the unhealthy or sin commodities to which excise tax is imposed in a greater proportion as compare to the higher income level. There is negative relationship between income and part of income which is spending on sin commodities. For example the imposition of tax on gasoline would be fall on the low income level and their utilities would be affected after increase in taxes.

In this model consumers are considered to be time inconsistent in their consumption decision. In the model author has considered the smoking decision which is more appropriate in time inconsistent structure. The basic purpose of the incidence analysis is to determine that who is going to bear the tax through different tax policies and the adequate measure for this analysis is utility. Bad commodities such as smoking have been under discussion among policy makers and academics. The important point here is that tax on harmful addictive commodities is equal to the external cost and such taxes are highly regressive.

Conclusion

Government basically collects taxes to generate revenues the important thing is that through which procedure it is being collected and who is going to bear the larger part of tax. After implementation of tax what would be the effect of tax on the welfare of the economy. Redistribution of income can be increased through taxation. Employment can be increased through labor income taxation. Welfare of the economy can be increased through sin taxes. Taxation on the unhealthy commodities leads to increase the welfare of the economy.

References:
Bingley, Paul and Lanot, Gauthier (2002), ” The incidence of income tax on wages and labour supply”, “Journal of public econmics”, vol: 83, page 173-194

Chae, Suchan (2002), “Tax incidence with bargaining”, “Economics Letters”. Vol: 77, page 199-204

Fullerton, Don and Heutel, Garth “The general equilibrium incidence of environmental taxes”, “journal of public economics”, vol: 91, page 571-591

García, José Ramón and Sala Hector, (2008), “The tax system incidence on unemployment: A country-specific analysis for the OECD economies”, “Economic Modelling”

Gruber, Jonathan and Koszegi, Botond (2004), “Tax incidence when individuals are time-inconsistent: the case of cigarette excise taxes”,” Journal of public economics”, vol: 88, page 1959-1987

Hamilton, Stephen F. (1999), “Tax incidence under oligopoly: a comparison of policy approaches”, “Journal of public economics”, vol: 71, page 233-245

Kotakorpi, Kaisa (2008), “The incidence of sin taxes”, “Economics Letters” vol: 98, page 95-99

Kubik, D. Jeffrey (2004), “The incidence of personal income taxation: evidence from the tax reform act of 1986”, “Journal of public economics”,
vol: 88, page 1567-1588

Petrucci, Alberto (2006), “The incidence of a tax on pure rent in a small open economy”, “Journal of public economics”, vol: 90, page 921-933

Ruffle J.Bradley (2005), “Tax and subsidy incidence equivalence theories: experimental evidence from competitive markets”, “Journal of public economics”, vol: 89, page 1519-1542

Tax Incident Essay