Tax evasion: It’s all Greek to me

The best solution to the problem of tax evasion is to simplify both the tax and the regulatory environment
 

Periodically for the past two years we have been bombarded with stories about the Greek financial mess. The Greeks and several other countries in the Eurozone have very large deficits. The bond vigilantes have been attacking these countries’ sovereign bonds, driving the level of interest to unsustainable levels. Since many of the local banks and often other Eurozone banks hold sovereign bonds as part of their mandatory reserves, a local fiscal crisis has metamorphosed into a European wide banking crisis. The Germans could help out. They could agree to shoulder part of the debt by allowing the Eurozone countries to issue Euro bonds backed by the credit of all of the countries. But they won’t. The simple reason is that they don’t feel responsible for a country where everyone evades taxes.

 

Certainly tax evasion is rampant in Greece. The Greek government’s tax revenue is about 52 billion euros a year. It is estimated that they lose up to 45 billion euros a year due to tax evasion. This is certainly an alarming number, but determining the size of tax evasion is perhaps nothing more than an educated guess. If you believe the number above, the tax evasion in Greece was 46% of potential revenue. According to the Greek Central Bank, it is one third, still a very large number.

 

Greece definitely collects less than the other members of the Eurozone. The average tax revenue for Eurozone members is about 40% of the gross domestic product (GDP). Greece collects only 33.2%. But it is just below the Czech Republic at 33.8% and Poland at 34.8% and well ahead of Switzerland at 29.4%. None of those countries seem to have a financial crisis. The reason Greece has troubles is that it spends more than it takes in. The gap is 13%. Interestingly the US is in a similar position. Its tax take is only 27% while it spends 40% of its GDP, the same amount as Greece.

 

Why can’t Greece collect taxes? Social scientists love to ascribe cultural aspects as reasons for poor tax collection. The Greeks have low “tax morale”. The Greeks view their society and government as corrupt. So they do not feel any moral obligation to support it with taxes. The act of breaking the law by not paying taxes is simply doing what everyone else in their society is doing. With a score of 80, Greece does not rank that high on Transparency International’s Corruption Index. But it is collects about a third of its GDP in taxes. China has a better score (75), but only collects 17% of its GDP. Malaysia’s score is 60, but only manages to collect 15% of the GDP.

 

Still I find the idea that the Greeks are somehow culturally doomed to be tax evaders rather simplistic. Law and economics studies have consistently shown that the probability of a criminal act is a function of the severity punishment and the risk of getting caught. Tax evasion is defined as using illegal means to avoid taxes. This usually involves some sort of misrepresentation or outright fraud. But a complex tax code with high marginal rates and a myriad of exemptions is one of the best ways to provide the legal means and the economic incentive to avoid the tax. In Japan tax rates are rather low and only 1% of wealth is held offshore. In Europe with high marginal rates the number is over 10%.

 

Ideally good tax laws have three goals: Equity, competitiveness and the generation of sufficient public revenue. They rarely achieve any of these goals because they are designed by politicians often to satisfy special interests. These provisions once enacted are almost impossible to get rid of no matter how foolish. In China small-to-medium sized companies have a gross profit margin near 10%, but the VAT (value-added tax) was 17%. If the companies actually complied, 90% would go out of business, so instead they all avoid the tax.

 

The size of tax evasion is directly correlated to the size of the underground economy. In Greece the underground economy is estimated to be about 27%, which means a lot of the commerce goes untaxed. The problems in Greece pale compared to Russia where the shadow economy is over 43%.

 

The best solution to the problem of tax evasion is to simplify both the tax and the regulatory environment. A system free of special deductions, credits, and exemptions is easier to use and enforce. Simplified regulations encourage firms to do business in the regular economy. But the complexity benefits a plethora of specific special interests which will fight tooth and nail to protect it. Politicians will only act when there is no alternative. To stop a crisis would take a simple rewriting of the law, but the law probably will not be rewritten until there is almost total collapse.

 

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected].)

Comments
Vaidya Dattatraya Vasudeo
1 decade ago
Plus make the penalties extremely, with no options to give any concessions, for any reason whatsoever. This is the point where the penalties become teethless.

Secon stop generating Abhay Yojanas. Not only in I.Tax but every where. Plus make an act that any elected person who is in arrears would lose his seat and no person who is in arrears to the govt. can contest any elected post.
Free Helpline
Legal Credit
Feedback