Cheating Uncle Sam

Back in 2005, IRS officials released a major new report on the "tax gap," the difference between what Americans owe in federal income tax and what they actually pay. The next year, an IRS update to the data in the original analysis put that gap at a stunning $345 billion a year.

But left unclear in this IRS data dump: Who exactly is cheating at tax time?

Now we know.

America's tax cheats, says an analysis of IRS data that surfaced last week, come disproportionately and overwhelmingly from the ranks of America's rich.

Americans who make between $500,000 and $1 million a year underreport their incomes by a whopping 21 percent. That's triple the 7 percent "misreport" rate of taxpayers who make between $30,000 and $50,000 and well over double the 8 percent cheating rate by taxpayers between $50,000 and $100,000.

The raw data behind all these stats originated in the IRS tax gap research, an undertaking that examined 45,000 randomly selected returns from 2001. In the paper that went public last week, two analysts -- IRS economist Andrew Johns and the University of Michigan's Joel Slemrod -- have broken the data from this massive audit effort down by income level.

The IRS original reports on the 2001 "tax gap" data included no income-level analysis. The IRS did release data, in these reports, on the categories of income that go underreported, data that help explain the new finding that the wealthy do most of the nation's tax cheating.

Average Americans get most of their income from wages, salaries, and tips. Only 1 percent of this income goes unreported, IRS investigators found in their original research.

Rich Americans, by contrast, collect huge chunks of their annual income from capital gains and business ownership. Business income went unreported by 43 percent in 2001, capital gains by 12 percent.

The newly published income-level analysis from Joel Slemrod and Andrew Johns does offer up one head-scratcher of a stat: America's very richest -- those who make over $1 million a year -- show lower cheating rates than taxpayers in the $500,000 to $1 million range. But Slemrod told Forbes last week that he's not particularly "comfortable" with that finding.

The super rich, the Michigan economist went on to explain, were likely exploiting tax shelters in 2001 that the later IRS audits simply did not detect.

Indeed, Forbes points out, the federal government is now suing the Swiss banking giant UBS "for the names of 18,000 wealthy Americans it believes may have had unreported Swiss bank accounts."

So what do the new tax cheating numbers, in the end, tell us about the contemporary United States? The United States has become even more top-heavy than the best of the official inequality statistics would have us believe. The best stats use income data from tax returns. These returns, last week's revelations help us understand, don't tell the full story.

The rich, in other words, are grabbing off substantially more of the nation's wealth than we ever imagined.

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