Becker and Posner engage in an interesting discussion today of the economics of tax evasion on the TaxProf listserve, asking why there is such good compliance and not so much tax evasion as a rational homo economicus would suggest. Becker, of course, was one of the first to apply cost-benefit analysis to crimes. I've always been rather dubious of those economic analyses, because it is so convenient to set the assumptions to produce the desired outcomes, and forget inconvenient externalities. In spite of my skepticism about the results of economic analysis, I find that it sets an interesting framework with which to approach an issue, that can shed interesting light on human behavior and critical factors in making policy decisions.
Becker concludes that audits, sanctions and other deterrence merits do affect compliance rates, but are not alone able to account for the fairly high compliance rates among advanced countries. He concludes that it may well be that an exogenous factor is operating--a sense of moral duty to pay one's taxes.
Posner, predictably, disagrees with that conclusion. He claims that there is more to deterrence than meets the eye, especially since information about the best ways to evade taxes is hard to come by for most people. Adding the information costs to higher costs to evasion than Becker assumes--audits aren't random, once audited a future audit is more certain--means there is less of a gap than Becker considers. But those arguments are only tinkering at the edges, which Posner essentially admits when he puts forth is third argument. Here's the excerpt from his concluding argument.
Every dollar spent by the Internal Revenue Service on enforcement brings in several dollars in additional tax revenue, suggesting that an expansion in the IRS’s budget would be necessary to equate the marginal benefits of tax enforcement to its marginal costs. But this suggestion ignores the fact that the benefits are, as a first approximation, merely income transfers, whereas the marginal costs of tax enforcement are social costs. If taxes are evaded, the resulting shortfall in tax revenues is made up by increasing the tax rate, and there is no social loss unless the increase has worse misallocative effects than the evaded taxes would have had, had they not been evaded. One reason, therefore, that tax evasion is widespread is that it may be cheaper from an overall social standpoint to have slightly higher tax rates than to devote additional resources to law enforcement, though the first-best solution might be stiffer penalties, especially monetary penalties. Deliberately lax enforcement would then explain the amount of evasion.
Now, I find this last argument questionable for all sorts of reasons. First and foremost, the idea that whenever tax revenues fall short because of tax evasion it is a simple matter to merely raise the rates and recoup the lost amounts, resulting in "no social loss" strikes me as absurd, in the US at least. Raising rates is politically extraordinarily difficult, because right-wing groups (and their expensive lobbyists and think tanks) have pushed tax cuts as the panacea for all social, moral and economic problems for decades. In fact, tax evasion plays into the right-wing agenda for starving the government "beast" of funds, resulting in the type of argument frequently made by Jim Saxton's reports for the Joint Economic Committee that evasion of a tax is a justification for eliminating the tax, not for squelching the evasion. It is relatively easy to convince ordinary people that any tax increase--even one that has not realistic possibility of falling on them because it is targeted at high-income taxpayers--is a bad idea, since about 40% of the American electorate think they are in the top 5% of the income distribution. And of course, the rhetoric has for so long been focused on labelling government as an "other" that is bad and privatization that puts public goods and public needs into private corporate hands as unambiguously good, making the possibility of raising rates to compensate for evasion even harder.
But are the benefits of tax enforcement merely "income transfers" while the costs of tax enforcement are clearly "social costs", as Posner claims? I don't think so. Tax enforcement has important institution-reinforcing value, as citizens are encouraged to think of themselves as citizens who participate together in government to provide for the common good in ways that each individually cannot do. Good tax enforcement encourages those who do comply out of a sense of moral duty to continue to do so, while lax enforcement results in some feeling like they've been snookered into complying while others live high on the hog from their evasive gains. Since nobody likes to be played for a fool, lax enforcement and visible cheating tend to weigh against the sense of duty to the democratic system and fellow participants. In other words, there are social benefits from appropriate enforcement that go well beyond the mere income transfers that it achieves or even the good uses to which tax revenues are put, one of which is the reinforcement of the shared sense of moral duty to support the common good.
I think one of Posner's problems is that he looks through a very narrow window that sees the compliance/evasion issue--and even the question of moral duty--as a question of obey or disobey the law. That misses the deeper and more profound concern that I think at least partially underlies our compliance with tax laws--the acceptance of a shared core set of values and institutional priorities.