Saturday, April 9, 2011

Guess what I am doing this weekend?

One clue -- it will take 2-3 hours on a computer.  Another -- it is something that I have to do, either myself or pay someone to do it for me.  Giveaway clue -- must be done by April 15 every year. 

The United States is one of the few countries in the world where there is a remarkably high rate of compliance with income taxes.  Chicago economist Casey Mulligan reports in a NYT blog entry that 99% of wage and salary income is reported.  The economic puzzle, Mulligan notes, is that the odds of being audited are quite low (1%) and the penalty for being caught is quite modest (10% of the under-reported amount).  For instance if I received a $10k check on a consulting gig and failed to report it (perish the thought), there is a 1% chance that I would have to pay taxes on the $10k plus a $1000 fine.  Assuming taxes are about 40%, that means there is a 99% chance that I get to avoid $400 in taxes and a 1% chance that I have to pay $1400.  You never get odds that good at a race track or casino. 

Mulligan notes that compliance is much higher for income reported on W-2 forms than for self-employment income or payroll taxes for household help, which is consistent with the odds of getting caught for under-reporting being much higher on the former.   Also audits are targeted, not random.  For instance, claiming a home office deduction raises a flag. 

In all too many other countries, payroll data is not efficiently communicated to the federal government, which makes it much easier for wage and salary workers to under-report income.  I have told many of my colleagues in Latin American countries that many of their budget deficit issues would go away if they would adopt the methods of the IRS.  Presumably a critical majority of those in power likes things the way they are in those countries, e.g., more discretion in enforcement allows them to reward friends and punish enemies. 

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