Tax Evasion Phenomenon in Our Society

By Revanza Almaas, a Directorate General of Taxes officer

Tax systems play a crucial role in society as they are responsible for generating revenue for government expenditures and redistributing wealth. However, the evaluation of tax systems cannot be solely based on optimal tax theory. Other factors such as horizontal equity, the costs of administration, political constraints, and incentives for tax evasion also need to be considered when designing tax systems. The last one is what we are about to discuss.

Tax administration, the backbone of our functional society, faces a persistent problem: sidestepping tax obligations. Yet, before discussing deeper about this, we must recognize two distinct forms of it. Tax avoidance and tax evasion, though often used interchangeably, represent vastly different approaches to reducing one's tax burden.

Tax avoidance operates within the legal boundaries. It's the changing in financial behavior to minimize one's tax liability, like choosing a tax-deductible expense or maximizing deductions. It's a legal right, accessible to everyone, rich or poor. Tax evasion, in contrast, crosses the legal threshold. It's the act of hiding income or assets, making cunning schemes to avoid paying the tax owed. Tax-evasive business may keep two sets of books, one for the taxman and one for reality. These are evasions, hurting an equitable tax system.

Tax Evasion: How They Play It

Since the birth of tax itself, the tax evasion has been a temptation for those seeking an unfair advantage. However, the modern age has made it harder for governments. Globalization, the rise of the internet, and increasingly complex financial instruments have created fertile ground for various evasion schemes. The size and complexity of financial transactions make it a big task for Directorate General of Taxes to track every rupiah and every hidden asset.

The methods employed by tax evaders are varied. Here are some of the most common criminal ways.

• Double bookkeeping: Maintaining separate sets of records, One records the actual business, and the other is shown to the tax authorities
• Cash-based transactions: Conducting business in cash, leaving no traceable paper trail for authorities.
• Underreporting income: Failing to disclose all taxable income, a widespread yet risky practice.
• Offshore accounts: Hiding assets and income in foreign jurisdictions (outside Indonesia) with lax regulations
• Claiming false or overstated deductions: Taking the advantage of deductions, making unsubstantiated charitable deductions to overstating travel expenses.

Tax evasion, unfortunately, remains a prevalent issue in Indonesia. Despite efforts by the Indonesian government to tackle tax evasion, the practice still persists due to several factors. Various reasons can come into play. Some taxpayers may have a low tax morale or believe the government wastes their tax money or uses it for purposes they disapprove of, leading them to feel justified in evading. Low perceived risk of getting caught can also contribute. If taxpayers believe the chance of detection and punishment is low, they may be more likely to take the risk of evading. If someone sees others evading taxes without consequence, they may be more likely to see it as an acceptable option (normalization).

To effectively address it, we need to understand the thought process behind it. From an economic standpoint, tax evaders make rational decisions based on marginal benefit and marginal cost. They weigh the potential gain from not paying taxes (the amount saved) against the risk of getting caught and facing penalties. This risk can be expressed as the expected marginal cost, which is the marginal penalty times the probability of getting caught (MC = MP × ρ).

In this uncertain world, evaders act based on the expected value of their options. They will continue evading as long as the marginal benefit (the tax amount saved) outweighs the expected cost. However, if the chance of getting caught is high enough, or the penalties are severe enough, the expected cost might become too high, making evasion unattractive.

Coping with Tax Evasion

By understanding the reasons and rationale behind tax evasion, policymakers can design more effective strategies to combat it. This can involve a combination of measures aimed at.

1. Increasing the perceived risk of getting caught: This can be achieved through improved detection methods, data sharing between government agencies, and stricter enforcement.
2. Raising the penalties for evasion: Making the consequences of getting caught more severe can deter potential evaders. Even if the chances detection by tax authorities are slim, the marginal cost of evasion can remain high if the penalty is big enough. Even if only one tax evader were caught each year, but their punishment is made public, the expected cost of tax evasion would deter many taxpayers.
3. Simplifying the tax code and reducing compliance burdens: This can make it easier for taxpayers to comply with the law and reduce the temptation to evade.
4. Promoting ethical behavior and social norms: Encouraging a culture of honesty and tax compliance can help to reduce evasion over the long term.

In 2022, Directorate General of Taxes (DJP) succeeded in uncovering a tax evasion case worth IDR 17.8 trillion. DJP has also increased the number of tax audits, especially for taxpayers with high potential. The government has also increased international cooperation in fighting tax evasion. One of which is following the OECD Inclusive Framework on Base Erosion and Profit Shifting (BEPS).

The fight against evasion isn't hopeless. Technological advancements like data analytics are being harnessed to track suspicious transactions and identify patterns that might indicate foul play. Private cooperation is crucial, with numerous parties sharing information and closing loopholes exploited by evaders. Additionally, public awareness and a public shift towards goof tax practices can create a powerful deterrent.

Remember, tax evasion isn't just a victimless crime. It threatens essential public services, widens the gap between rich and poor, and erodes trust in institutions that build our society. By understanding the nuances between avoidance and evasion, and supporting efforts to combat evasions, we can safeguard a fairer and more equitable tax system for all.

*) This article is the author's personal opinion and does not reflect the attitude of the agency where the author works.

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