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    Off-Shore Tax Evasion Is Talked About But How Widespread Is It?
    By News Staff | April 11th 2014 08:54 AM | Print | E-mail | Track Comments

    The IRS and the Recording Industry Association of America share one thing in common; if they ever actually collected all of the estimated money they claim they are owed, they could buy a small country with it. With the RIAA, they always made piracy projections under the assumption that every illegal download imaginable was a lost sale and the IRS believes every business and resident exists to fund their coffers. 

    One recent claim is that billions of dollars are lost to "round-tripping", where an investor moves money offshore and then invests with the offshore money in US equity and debt. Since they are now 'foreign' investors, they don't have to pay capital gains taxes. Sounds arcane, right? If you don't know how you would even do that in a practical way, you are not alone, and a new paper in the Journal of Finance doesn't clear it up - it uses an estimate that is positively IRS/RIAA worthy, claiming that somewhere between $34 billion to $109 billion was hidden this way by 2008 and it may have meant $8 billion or more in lost revenue. In practical terms, in the history of round-tripping the government lost enough money to run the government for 1 day. Clearly if we are being robbed, it isn't by foreign portfolio investment capital gains taxes.

    The authors correlate every 1 percent increase in the top U.S. tax rate leads to an increase of 2.1 percent to 2.8 percent in foreign portfolio investment (FPI) from tax havens.  


    Which are legal and which are evaders?

    The problem with estimates so broad as to be almost meaningless is that people will pick and choose the one they want. That's not accounting, it sure isn't science. Not all investments from tax havens are dubious and the scholars employed a suspect strategy to identify what they believed might be round-tripping. They declared a cause and effect relationship between tax rates and investment and then look at changed in investment levels after changes in U.S. tax rates. They matched the results with whether or not the U.S. has a bilateral Tax Information Exchange Agreement (TIEA) with countries. Having created a premise which they knew was going to match their desired result, they collected data from both the U.S. Federal Reserve and the U.S. Treasury and correlated a decrease of up to 32 percent in both equity and debt investments when the U.S. creates a TIEA with a country, which presumably allows the IRS to get more data about investors.. 

    Co-author Michelle Hanlon, a professor of accounting at MIT, says, "It's very hard to identify tax evasion, because obviously people are trying to hide it. Once we started seeing the data, we realized we could try to tackle this problem. We had to do a lot of tests to try to isolate the effect we're looking for, [and] we think it's a big step to try to put some numbers around this phenomenon."


    Hanlon suggests that greater international cooperation will at least make this type of tax evasion more difficult and riskier and there may be something to it. If more countries have agreements with the US, assuming they are ethical, it would drive tax cheats to more and more risky companies. But one day worth of revenue is not going to mobilize the government to create agreements with countries that are already ethically sketchy. 



    Paper: "Taking the Long Way Home: U.S. Tax Evasion and Offshore Investments in U.S. Equity and Debt Markets," co-authored byEdward L. Maydew of the University of North Carolina, and Jacob R. Thornock of the University of Washington.