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The amount of tax cheating will increase significantly during the Obama administration—both with regard to the number of people who do it and the amounts by which they underpay their income taxes.

Why?

It’s not primarily because Obama famously nominated several tax cheats to be administration officials (Tom Daschle, Nancy Killefer)—including Treasury Secretary Geithner whose department includes overseeing the IRS.

Why cheating will increase under Obama

There are three reasons why tax cheating will increase under Obama:

• He is making the tax law palpably unfair
• He is increasing the amount tax cheats save by increasing the tax rates people pay
• He is not increasing the IRS enforcement budget or staff

In the U.S., income taxes are an honor system. America has had an unusually high degree of compliance by its citizens. European countries have marveled at our compliance rate and asked how we do it.

Here is a quote from an academic paper on that issue (Culture differences and tax morale in the United States and in Europe):

Our results again indicate that individuals in the United States have the highest tax morale across all countries, followed by Austria and Switzerland. We also find a strong negative correlation between the size of shadow economy and the degree of tax morale in those countries.

The fact that Americans have been more willing to comply with income tax laws than the citizens of any other country is a great asset to the U.S. It makes it much cheaper to collect tax dollars per thousand dollars of taxable income.

Obama is turning America into Europe

Critics of Obama have accurately alleged that Obama and his supporters are Europhiles who believe the European approach to government (huge) and the economy (universal health care, heavy unionization, socialism) is better than the American one and they are now taking us straight to the European approach. In fact, Europe is chronically sick economically, and they will be sicker now that the United States is no longer a strong economy to provide them with international trade and tourist dollars.

European unemployment

Here are some 2004 comments on European unemployment from the U.S.-based National Bureau of Economic Research:

Until the end of the 1960s, unemployment was very low in Europe and the talk then was of the "European unemployment miracle." The miracle came to an end in the 1970s, when unemployment steadily increased. It kept increasing in the 1980s. It appeared to turn around in the mid-1990s, but the decline is (temporarily?) on hold. For the European Union as a whole, the current unemployment rate is still very high, around 8 percent.

Second, the evolution of the average European unemployment rate hides large cross-country differences. In the four large continental countries -- France, Germany, Spain, and Italy -- the unemployment rate has increased steadily and remains very high, around 10 percent. (The Spanish unemployment rate has been cut in half since its peak, but remains above 10 percent.) In a number of smaller countries, notably Ireland and the Netherlands, unemployment increased until the early 1980s, but has steadily decreased since then. Unemployment is less than 5 percent in both countries today. In a number of other countries, notably Sweden and Denmark, unemployment has remained consistently low -- except for a bout of high cyclical unemployment at the start of the 1990s. Unemployment is below 5 percent in both countries today.

Third, at a given unemployment rate, individual unemployment duration is substantially longer, and flows in and out of unemployment substantially lower, in Europe than in the United States.(2) And, the increase in European unemployment reflects an increase in duration rather than an increase in flows. As a result, duration is high. In Germany and Italy for example, more than half of the unemployed today have been unemployed for more than one year.

Class warfare

Europeans have long viewed the world as a struggle between classes in which workers are the heroes and the wealthy are villains. One reason they cheat more on their income taxes is that they believe their tax systems are nothing but Robin Hood theft with a political spin: socialist politicians in Europe use their tax systems to rob from the rich and give to the socialist voters. High-income earners understandably feel no moral duty to cooperate with such a system. Obama has adopted that approach, copying the Depression-era anti-rich rhetoric of FDR and, earlier, of Karl Marx.

Using the Internal Revenue Code as a political weapon

There is no question that Obama and his current Democrat allies in Congress are taxing Republicans to give to Democrats and doing so for purely political purposes. Indeed they have been doing it for so long that it is now generally true that Republicans pay taxes and Democrats do not. Someone needs to do a survey of the amount of taxes paid by registered Democrats and the amount paid by registered Republicans. No doubt, the discrepancy is already stark and getting starker. Indeed, a major part of Obama’s “stimulus” law gives people who paid no income taxes a “refund” which is simply a transfer of wealth from Republican voters to Democrat voters. Critics have called it “welfare.” It’s worse than welfare. At least with welfare, you have to tell a sad story to get the money. With the Obama “refund” to voters in the Democrat demographic, you don’t have to do anything. There is no means test at all. Some of the people who received that money are no doubt well off but they do not happen to have taxable income because their money is in tax-free municipal bonds or some such.

During the campaign, Obama told Joe the Plumber that he would “spread the wealth.” That means confiscate the life savings and/or income of Republicans and give it to Democrats.

The underlying moral rationalization is that the rich stole the money from the poor to begin with so it’s moral to steal it back and get credit at the polls for doing so. That’s a myth. In fact, the majority of the rich are simply hard-working people. They stole from nobody. The moral code they are likely to adopt in the near future—that Obama, Pelosi, et al are stealing their hard-earned money through the Internal Revenue Code to buy votes with it—will be based on an accurate depiction of what’s really going on.

To those who point to true crooks among the rich, “Prosecute them.”

Tax cheating by using a sleazy accountant or lawyer

One form of tax cheating is to seek out accountants and tax lawyers who advocate new ways to use parsed wording of tax laws to reduce the taxes of the wealthy. From time to time, you see media stories where a particular adviser’s methods were declared illegal and a court upheld the IRS decision. [I am the author of the book Aggressive Tax Avoidance for Real Estate Investors which is now in its 19th edition. That book tells the legal ways to minimize taxes. I was audited in 1988 by the IRS—many suspect because of my book. The IRS auditor asked for a copy of it and I gave it to her. She read it. She told me when she was done that she, “learned a lot” from it. The audit was a Taxpayer Compliance Measurement Program (TCMP) audit. That means they audited every single line of my 23-page return. The result was I owed no additional taxes and I got a letter of commendation from the IRS.]

Cheating by using sleazy accountants and lawyers as cover will increase under Obama.

Cheats are rational

At Harvard Business School, we learned that you make economic decisions using expected value. Expected value is simply the amount you will get or save multiplied by the probability that you will get or save it. In my Aggressive Tax Avoidance... book, I show the calculations with regard to the probability of being audited, losing the audit, and the interest you have to pay. I did not do those calculations with regard to violating the law, that is, tax deficiencies where the taxpayer owes penalties in addition to interest and back taxes. Nor did I do them with regard to criminal violations that impose fines and/or prison sentences. But tax cheats will do those calculations either formally as I do in my book or informally along the lines of, “The amount I save is huge, the chances of getting caught is low, screw Obama and Harry Reid and all that crowd!”

In his 2008 book The Logic of Life, economist Tim Harford explains with extensive data how criminals calculate, informally, the odds of getting caught and the benefits of not getting caught. When they conclude crime pays, that is, the expected value of committing the crime is positive, they commit crime. The best-selling book Freakonomics draws similar conclusions about drug dealers.

You also see it in other taxation like taxes on cigarettes and diesel fuel. The higher they push the taxes on cigarettes and diesel fuel, the greater the incentive to sell black market cigarettes (usually bought in a low-tobacco-tax state like North Carolina and resold under the table in high-tobacco-tax states) or diesel fuel (which is chemically the same as untaxed Number 2 heating oil) and the more black market trafficking goes on. By definition, the black market sales would disappear if the taxes did.

The higher Obama and the Democrats raise tax rates on the rich, the greater the incentive to cheat and the greater will be the incidence and amount of the cheating. As always, the more cheating, the more others will be forced to pay either in the form of higher-still tax rates or in the form of cuts in government programs or higher interest on government bonds used to borrow money to make up for cheating shortfalls.

I have heard of no increased IRS staff in Obama’s programs. I suspect he opposes that because the IRS is unpopular and Obama wants to be popular. Maybe he will announce a new part of the IRS—the Special Enforcement Division to Stop Republican, I mean, High-Income Tax Cheats, thereby avoiding the enmity of his Democrat tax cheat supporters—whom he has to see frequently at cabinet meetings and such.

Wealthy tax cheats versus Democrat IRS auditors

Even if he increases enforcement, America will be worse off because the greater the incentive to cheat, the greater the cost of stopping cheating. But America will probably become a nation of wealthy tax cheats and an army of Democrat IRS auditors before anyone wises up. And this sort of social compact—“tax morale” as the academic study above calls it—is like virginity. It cannot be restored once lost.

The 3/2/09 Forbes magazine list on its cover the page 32 article: “Taxes, How to cheat like a pro!”

John T. Reed

I appreciate informed, well-thought-out constructive criticism and suggestions. If there are any errors or omissions in my facts or logic, please tell me about them. If you are correct, I will fix the item in question. If you wish, I will give you credit. Where appropriate, I will apologize for the error. To date, I have been surprised at how few such corrections I have had to make.