How Widespread is Tax Evasion?

by Peter Dizikes, MIT News Office

Tax evasion is widely assumed to be an eternal problem for governments – but how widespread is it? For the first time, a new study, co-authored by an MIT professor, has put a cost on a particular kind of tax evasion, known as “round-tripping,” that the U.S. government has been trying to thwart.

In round-tripping, U.S. investors move funds to offshore tax havens, then invest in U.S. equity and debt markets with these “foreign” funds. In essence, the U.S. investors are disguising themselves as foreign investors, who are not subject to the same tax rates on capital gains and interest income. The money is said to have made a “round trip” since it originates in the U.S., and winds up back in U.S. markets.

According to the study, published in the Journal of Finance, 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. As of 2008, some $34 billion to $109 billion of FPI from those havens appears to have been invested in the U.S. via round-tripping, leading to a loss of $8 billion to $27 billion in tax revenue.

“The higher the tax rate, the more securities appear to be purchased from tax haven jurisdictions,” says Michelle Hanlon, a professor of accounting at MIT. “This seems to indicate that U.S. individuals are pretending to be foreigners who then invest in the U.S. markets.”

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