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Oct 23 2008 12:34PM EDT

Rich Cheat Most on Taxes

We're learning more about what it's like to be Joe the Plumber everyday: A new study by Joel Slemrod of the University of Michigan and Andrew Johns of the Internal Revenue Service finds that misreporting of income and tax liabilities is highest among the rich.

Applying an audit method used by the IRS to calculate misreported income, Slemrod and Johns found that one out of five people who earn between $200,000 and $500,000 annually lie about their real incomes. The misreporting rate is much lower for those who earn less. For example, eight percent of those earning between $50,000 to $70,000 were tax cheats. (The data is from 2001.)

The following chart shows the percentage of income tax returns with misreported income for different income brackets:

misreport.gifIt looks like misreporting drops after incomes hit $1 million, but Slemrod thinks that's just because the IRS hasn't caught up with how the super-rich evade taxes. He told Forbes:


"I just don't know whether these audits were able to track down really sophisticated noncompliance or Swiss bank accounts. They may underestimate it (noncompliance) at the top."

The rich are likely socking away income from businesses since earlier research has found that business income accounts for two-thirds of understated individual earnings.

 It would be interesting to see what happens to these figures under Barack Obama's proposed tax plan. Obama wants to raise income taxes on families earning above $250,000. I put that to Slemrod who said that there isn't a strong consensus on how earners would react to the higher tax burden.

"I think the average person on the street would say 'higher tax rates, more evasion,' but that's not obvious even in theory," he said. "A higher tax rate means the tax savings you get from a dollar of underreported income goes up, but it also means the penalty of under-reporting a dollar of income, if you get caught, goes up because penalties for cheating are proportional to how much you cheat."

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