Evans On The Economy -- Tax Cheats Snub Spend-Crazy Feds

There would have been no federal budget deficit last year had tax cheaters paid all they owed.

Soon it will be everyone's favorite day -- April 15th. How much will you owe? Federal income taxes are only the beginning. Last year, federal income taxes totaled $932 billion, or about $6,650 per employee. But people paid $1.286 trillion in other federal taxes, mostly Social Security taxes. And -- keep those calculators going -- the state and local tax bill totaled $1.14 trillion.

Directly or indirectly, employees and proprietors paid this entire bill of $3.358 trillion, or almost $24,000 per employee. Total compensation earned by employees and individual proprietors last year was about $8.2 trillion, so, by my calculation, this means 40% of your income went to various government agencies.

And where did that 40% of your income go? Most of it, if you're under 65 and working at a regular job, went to the less fortunate. The numbers are stunning. Federal expenditures were $2.55 trillion, with $495 billion going for national defense and another $272 billion going for purchased goods and wages paid. At the same time some $1.69 trillion was transferred to someone else -- well, actually a lot of someone elses. That's some federal case.

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Some people think that is too much to pay. Well, almost everyone thinks it's too much to pay. But some people do something about it. They cheat.

According to a recently updated Internal Revenue Service (IRS) study, federal income taxes were underpaid by $345 billion in 2001. Most of that was based on underreported income, and most of the gap was caused by individual proprietors who didn't report all their income or overstated their expenses. According to the IRS, non-farm proprietors' income reported for tax purposes was understated by a whopping 57%. The figure has presumably grown since 2001. A conservative estimate would be $400 billion for federal fiscal year 2005. To put that in perspective, the federal government budget deficit last year was $318 billion. So -- do the arithmetic -- if people hadn't cheated on their taxes, the federal government would not have had a budget deficit last year.

There is little doubt that the IRS figures are accurate. They may even be conservative. The IRS based its estimates on an extensive audit of 46,000 randomly selected units, which is more than enough to create a statistically robust sample. I have long said that Schedule C (Profit or Loss from Business) income was underreported by 50%. Apparently that figure has now risen to 57%.

These percentage figures are much higher than in previous decades, even though top marginal tax rates are much lower than they were before 1982. Possible explanations include: People are inherently less trusting of government than they used to be; the overall tax burden has risen, and there is more incentive to cheat; IRS enforcement activity has declined; with many legal loopholes closed off, people increasingly use illegal ones; and the tax code has become more complicated.

The pat answer is that the U.S. tax code has become more complicated. But, in my opinion, the answer is more complicated. It is all of the above.

Reducing the complexity of the tax code would certainly save tax-form filers -- or their accountants -- numerous hours. But it probably wouldn't change the basic ethic that the government doesn't deserve nearly all of the money it gets. President George W. Bush has announced plans to reduce the tax gap by $350 million -- less than 1% -- over the next few years. You know how successful that will be. Meanwhile, cheating, as a proportion of total tax revenues due, will continue to increase.

Michael K. Evans is chief economist for American Economics Group, Washington, D.C., and president of the Evans Group, an economics consulting firm in Boca Raton, Fla. Also see: Economic Outlook and Financial Market Outlook: Mike Evans' new blogs on the economy and stock market.

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