Tax Evasion and Inequality
Who evades taxes in developed economies? The question is fascinating in its own right and matters a great deal for the study of inequality because scholars typically rely on tax records for distributional information about income and wealth. If tax evasion is equally prevalent among the rich and the poor, it will not affect measured inequality. If the rich dodge taxes more than others, tax records will underestimate inequality.
In recent research (Alstadsæter et al., 2017), we set out to compute distributional tax gaps for the Scandinavian countries and correct inequality statistics for differences in evasion rates. As in many other studies of tax evasion, we rely on information from the audits that are conducted randomly by tax authorities.
However, tax audits are not well suited to describe tax evasion by the very wealthy because they generally fail to detect sophisticated forms of evasion involving shell companies and hidden offshore accounts; hence, a complementary data source is needed.
To address this challenge, we exploit a massive trove of data leaked from HSBC Switzerland, later known as the Swiss Leaks. In 2007 a systems engineer, Hervé Falciani, extracted the internal records of the bank and turned the data over to the French government. The documents leaked by Falciani included the complete internal records of the more than 30,000 clients of the bank. At the time, HSBC Switzerland was a major actor in offshore banking managing assets of about $120 billion or about 4% of all the foreign wealth managed by Swiss banks.
This HSBC leak is a unique source of information to study tax evasion because the leak can be seen as a random event and because it comes from a large and arguably representative offshore bank. With the help of the tax administrations in Denmark, Norway and Sweden, we have combined information about the roughly 500 Scandinavian individuals with HSBC accounts with detailed income and wealth data.
To study the distribution of offshore tax evasion, we determine the total net wealth of each of the roughly 10 million households in Scandinavia and compute a wealth distribution. In the figure, we then show the probability to own an unreported HSBC account by net wealth group. There is a striking wealth gradient in the prevalence of unreported offshore assets even within the top of the wealth distribution. Among the wealthiest 0.01%, around 1% held an account at HSBC.
We also consider other samples of individuals with offshore activities: owners of shell corporations in Panama, exposed in the so-called Panama Papers, and tax payers who voluntarily disclosed offshore assets in the framework of the Norwegian and Swedish tax amnesties. In all the samples, we observe a similar gradient in participation across wealth groups.
Moreover, accounting for differences in the average value of offshore accounts (conditional on having offshore accounts) makes the inequality in offshore wealth even more striking: our samples consistently suggest that around 50% of offshore assets belong to the wealthiest 0.01% and around 80% belong to the wealthiest 0.1%.
In conclusion, offshore wealth is extremely concentrated at the top of the wealth distribution.
While the micro-samples of offshore tax evaders are illustrative of the distribution of offshore tax evasion across wealth groups, they say little about the absolute level of offshore tax evasion within each group. To estimate total offshore evasion by wealth group, we need to make assumptions about the offshore assets that are not observed in the leaks.
In a first step, we use recently published available macro-data to estimate the stock of unreported offshore wealth owned by Scandinavians: we find that it amounts to around $50 billion, or around 4% of GDP, which is very low by international standards. In a next step, we allocate this stock of offshore wealth to wealth groups while applying the same distribution as we observed in the HSBC-leak, that is assuming that HSBC is representative of the offshore banking sector.
Finally, we compute the evasion rates implied by the stocks of unreported offshore wealth based on the actual income tax and wealth tax parameters of the tax system. Following this procedure, we estimate that the offshore evasion rate is low in the aggregate, less than 1% of total taxes due, but very high among the wealthiest, almost 25% for the top 0.01% of the wealth distribution.
Next, we combine the distributional estimates of tax evasion from the analysis of offshore accounts and from standard random tax audits to provide the most complete picture possible of the distributional tax gap.
Consistent with previous studies of tax evasion in developed countries, we find that the evasion rate is low in the aggregate: most types of income are reported by third parties and subject to very limited evasion. However, when considering tax evasion through offshore accounts, tax evasion is very high among the wealthiest, plausibly in the range 25%-30%.
Finally, we show that tax evasion has important implications for measured wealth inequality because of its highly uneven distribution across wealth groups. In Norway, for instance, the wealth share of the top 0.01% increases by around 25% when accounting for unreported assets on offshore accounts.