Catalonia’s Treasury and tax fraud

The North-American politician and scientist Benjamin Franklin said that in this world nothing is certain but death and taxes. In the latter case, the statement isn’t true, as taxes can be avoided.

In all countries people maneuver to reduce or avoid their tax burden. Some of those maneuvers are completely legal. For example, many big multinationals avoid taxes by transferring profits to subsidiaries located in countries where the corporate tax rate is lower. We also frequently see how top artists or athletes change their legal residence to countries where the tax rates are more advantageous. All of these cases could be called tax elusion: the avoidance of paying taxes by legal means, often by taking advantage of loopholes in tax laws or certain exemptions, deductions, or tax credits.

However, we can talk about tax evasion or tax fraud when the individuals take illegal actions to dodge or reduce their tax burden. The black market economy is a clear example of tax fraud. Professor Ignacio Mauleón, of the King Juan Carlos University, estimated in a recent paper from the Barcelona Economic Institute that the black market economy in Spain represents between 24% and 26% of GDP. This translates to 260 billion euros. This figure contrasts with the Scandinavian countries, which have percentages between 10% and 15% of GDP.

Therefore, the black market economy causes a huge loss of tax resources, in addition to a loss of equity and economic efficiency. It is difficult to quantify this, but a first approximation could be achieved, according to Professor Mauleón, by applying a median tax rate on the volume of the black market economy-- while assuming that there will always be a certain level of activity, which Mauleón estimates at 5% of GDP. The result is that 67 billion euros in tax resources are lost, some 6.5% of GDP. This is a very significant figure. It means that if you actually had access to these resources, the public deficit would practically disappear, and public debt would be much lower.

The Spanish regions that are clearly above the national median for black market economy are Extremadura, Andalusia, and Castilla-la Mancha, and those below the median are Navarre, Cantabria and Aragon. The differences can be explained by the unemployment rate, which has lately been a very influential factor in the creation of the black market economy, and for the productive structure of each region. Thus, less black market activity is found in the industrial sector, and more in service economies.

Consequently, some strategies for fighting tax fraud might consist of doing thorough inspections in the labor market, as we have said that the black market economy has a positive relationship with the unemployment rate. Also, we should encourage industry if this sector has the least black market activity. Particular targets could include high technology, telecommunications, biotechnology, and renewable energy.

As to the role of the tax administration in the fight against fraud, tax experts advise that the tax culture must be changed. We have a tax administration that has a very authoritarian relationship with taxpayers, considering them all as potential offenders. It has been shown that a strategy in the fight against fraud that is based solely in detection and penalties is not effective. This is not to say that there should not be inspections.

Many countries have already changed their old strategy for fighting tax fraud to another that regards the taxpayer as a potential client. The tax administration based on this new culture offers services to help the taxpayer in return for their tax obligations, and simplifies taxes and taxation processes. A very important factor is that by relating tax revenue to public services, the taxpayer can see what his taxes are paying for. Many studies have concluded that when the people know what their tax money is paying for, tax fraud decreases. It is a tax administration that generates trust, as the taxpayer sees that the government and the tax authority are acting honestly. This new culture has proven to be much more effective than the old style based on repression.

Now that we have begun to build the foundations of a Catalan tax administration to manage all of the taxes paid by Catalans, we should keep in mind these new strategies to fight tax fraud.