Agent-based Modeling of Tax Evasion

Chapter 10Modeling the Co-evolution of Tax Shelters and Audit Priorities*

Jacob Rosen, Geoffrey Warner, Erik Hemberg, H. Sanith Wijesinghe and Una-May O'Reilly

^* Select text, illustrations and figures for this chapter have been sourced from: Hemberg et al. (2016) © Springer Science+Business Media Dordrecht 2016. With permission of Springer.

10.1 Introduction

It seems Benjamin Franklin was only half right – death may be no less certain today than it was in 1789, but taxes are far from inevitable. In the United States alone, the so-called tax gap, which is the difference between the tax owed and the amount paid on time in any given tax year, amounts to a whopping $450 billion in lost revenue, much of it accounted for by individual taxpayer noncompliance. There are, of course, many innocent reasons for noncompliance, including simple ignorance or error, but a significant portion is due to deliberate, and sometimes fraudulent, activity in the form of tax shelters.

An abusive tax shelter, or scheme, involves a sequence of transactions within a network of related business entities. These transactions are specifically designed to create and transfer artificial losses to designated beneficiaries, who then claim those losses in order to reduce their overall tax liability. The associated networks are usually composed of flow-through entities such as partnerships, trusts, and S-corporations¹. Such entities do not pay tax directly, but instead pass any net income or loss to their owners. ...