Quantifying the effects of tax enforcement?

In a paper contained in the London School of Economics document “After the Drug Wars,” three distinguished drug policy men raise this possibility that enforcement doesn’t raise the price of illegal drugs.

I wonder if raising the price of tax-evading black market drugs that compete against legalized drugs is a different case totally. I keep thinking that post-legalization, the black market is a function of two variables, (relative) value and enforcement. After repeal of Prohibition, Roosevelt was big on enforcement, and it reportedly helped.

After looking at four attempts to quantify the effects of tax enforcement, I argue that tax enforcement is quite different from enforcing prohibition.

I.

When I worked for the Joint Congressional Committee on Taxation, we often heard suggestions that the way to pay for tax cuts was to hire more IRS agents. Like this, in the 1990 G.H.W. Bush budget:

“The President’s budget for fiscal year 1991, for example, proposes adding 3,600 staff to examine more tax returns, collect more unpaid taxes, and do other tax enforcement jobs. IRS estimated that with this additional staff, it would generate about $500 million of additional revenue in 1991 and about $6.5 billion by the end of fiscal year 1995.” http://www.gao.gov/assets/150/149315.pdf (GAO report questioning those numbers and suggesting other methodologies).

II.

In 2011, the “Ways and Means Committee of the Oregon State Legislature directed the Oregon Department of Revenue (DOR), in conjunction with the state’s Office of Economic Analysis (OEA) and Legislative Revenue Office (LRO), to develop a methodology of identifying tax receipts which result from DOR’s enforcement activities such as audits and collections.” http://www.oregon.gov/DOR/programs/gov-research/Documents/enforcement-revenue-budget-response-2012.pdf

This is the report that resulted: http://www.oregon.gov/DOR/programs/gov-research/Documents/enforcement-revenue-identification-2012.pdf. It may be useful, if only to illustrate the uncertainty.

III.

A trivial enforcement mechanism in France — substantiation of charitable deductions — “triggered a 75% drop in reported charitable contributions.” http://www.econ.upf.edu/docs/papers/downloads/1406.pdf

IV.

Another trivial case: “Measuring Illegal Activity and the Effects of Regulatory Innovation: Tax Evasion and the Dyeing of Untaxed Diesel,” http://people.ucsc.edu/~marion/Papers/Marion%20and%20MuehleggerRR13.pdf shows that payment of the diesel fuel tax increased dramatically after interchangeable untaxed home heating oil was dyed. The authors estimate that: “taxed diesel sales rose by approximately 26 percent post-dye, or 7.1 billion gallons per year. A first-order approximation of the welfare gain is therefore $2.8 billion per year.”

And quoting again from http://people.ucsc.edu/~marion/Papers/Marion%20and%20MuehleggerRR13.pdf, here’s an intriguing if useless observation:

“For instance, Baluch (1996) estimates that taxes assessed as a direct result of enforcement activity are 10 to 18 times greater than the cost of the enforcement activity. However, it is unclear what this tells us regarding the optimal level of enforcement, since we have little idea regarding the marginal return to enforcement efforts even if we have good estimates of the average return.”

[Baluch, Stephen (1996) Revenue Enhancement Through Increased Motor Fuel Tax Enforcement.]

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What’s below is a rehash, somewhat thrown together, of stuff I wrote earlier about alcohol.

There is lore that enforcement was a key element in making alcohol taxes work after Repeal of Prohibition.  The deliberate thrust of the government effort was to go after big enterprises with economies of scale.  The analogy for today, I suppose, would be to “Leave the Long Haired Country Boy Alone” and concentrate on substantial operations — for a long time, at least.

A prominent historian of alcohol taxation, Tun Yuan Hu, wrote that when policymakers discussed “post-repeal liquor taxation, . . . [i]t was generally agreed that the immediate objective should be directed to the elimination of the bootlegger.”[1]  Not raising revenue.

President Roosevelt’s team urged:

“keeping the tax burden on legal alcoholic beverages comparatively low in the earlier post prohibition period in order to permit the legal industry to offer more severe competition to its illegal competitor.  When that competitor has been driven from business the tax burden could be gradually increased.  Investigators . . . estimate that it will require three years of such competition to break the organization of the illegal industry.”[2]

As the re-imposers of alcohol taxes hoped, enforcement worked.  “From repeal of prohibition through 1937 the main efforts were directed toward the liquidation of organized bootlegging gangs, especially those operating in Northern metropolitan areas.  This syndicated type of illicit operation was virtually destroyed by the end of 1937, and since that time the control of production and distribution of illegal distilled spirits became largely a problem of coping with relatively small violators.”[3]

Quickly, legitimate business moved in to take the bootlegger’s place.  “[O]nce it ceased to be outlawed, the alcohol industry was no longer dominated by unregulated, illicit entrepreneurs. . . .  The leaders of the major alcohol industries are members of the economic establishment with an investment in maintaining order and obedience to law. . . . Now [in 1991], over a half-century since prohibition, it is easy to forget that all this was the outcome of self-conscious public policy and not the ‘natural’ result of market forces or national zeitgeist.”[4]

Even before enactment of taxes, here is some 1933 testimony, before the federal tax-writing Committees, of Luther Gulick, a tax expert who helped the authors of Toward Liquor Control, the Rockefeller Commission Report on Prohibition repeal:  “Bootlegging cannot be stamped out in the United States by low taxes.  [An initially] low tax rate will not solve the problem by itself.  It has got to be solved by law enforcement and by the recognition by the citizens of this country that they have more today to gain then they have to lose by buying legitimate liquors through legitimate channels, even if someone else can come to them and say, ‘Here, we have the same stuff at lower rates’–and probably they do not have the same stuff.  In many cases when we pay lower prices for illegal beverages than legitimate taxes require and demand, we are subsidizing the [illegitimate products] which serves to debauch our police, undermine our courts, and wreck our government machinery throughout.  Therefore, it is not only necessary to have taxes, but it is necessary to have rigid enforcement, and a new attitude on the part of the public at large.  It seems to me there is an opportunity for that new attitude.”[5]  Gulick hoped that “the people will join in seeing bootlegging stamped out, as has been revealed by the repeal vote.”[6]

But whether the public will want to stamp out the tax-evading market in marijuana after legalization is not clear to me.

Some people in the marijuana community, accustomed to law-breaking, think of marijuana prohibition laws as foolish, and not deserving of respect.  That pattern of thinking might not change overnight upon implementation of a tax-and-regulate system.  Already, in Colorado, open defiance of the new tax-and-regulate scheme is popping up.[7]

But success of a marijuana legalization plan does not depend on the reaction of the marijuana community alone.  Today, the public may be ambivalent about marijuana offenses.  That ambivalence may take the form, after legalization, of ambivalence about marijuana taxes.  In light of any perceived public ambivalence, prosecutors may choose not even to charge marijuana offenders.[8]  Even if offenses are prosecuted, juries could nullify the law – refusing to convict offenders.

Since marijuana prohibition has proved hard to enforce, a tax-and-regulate model may suffer, too.[9]  Enforcing laws against tax evasion, grand or petty, is no simple feat.  The public may condemn tax evasion less harshly than drug crimes.  After legalization, if the public winks at tax evasion, the black market will thrive.[10]  If tax evasion is widely tolerated, tax revenue will not materialize.  But if evasion of marijuana taxes is seen as a “fool’s errand,”[11] a revenue plan can succeed.  Indeed, citizens who think marijuana prohibition ill advised and who now wink at marijuana bootlegging might cooperate with law enforcement against tax evasion.  Throughout American history, “[m]aking drinkers pay higher taxes for their liquor and punishing tax evaders were state powers most citizens recognized; denying drinkers the right to buy their liquor was state imposition of one group’s morality upon another group.”[12]

Unless taxes are ultra-low, the life or death of the black market, and of the legal industry, will turn on enforcement of the new revenue laws.  And on public support for those laws.

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Optimal amount of crime

https://newrevenue.org/2015/05/29/optimal-amount-of-crime/#more-3800

May 29, 2015 § Leave a comment

For tax evasion, there’s an optimal level of enforcement, and an optimal level of crime. You can’t “wipe out” the black market. You can reduce it to a tolerable level. There’s an optimal size of the black market, probably consisting, as suggested below, of “relatively small violators.”

There is still moonshine being made in the mountains of North Carolina, I imagine, but not enough to matter – not enough to be an economic threat to the commercial liquor market that’s regulated and taxed. For law enforcement to scour the mountains every week in search of that last moonshiner would be hugely expensive to the point of being silly and counterproductive. No one I know buys non-tax-paid liquor, and you can’t find it on Craigslist. It took a while after repeal of alcohol prohibition for the black market in liquor to die down.

In 1794, when farmers in western Pennsylvania were ignoring the federal liquor tax, President George Washington, the Commander in Chief, mounted his horse and led 12,950 men (in a country with a population of 5,308,483) to make them pay tax. And they did.  That kind of enthusiastic collection of cannabis taxes seems implausible.  The public does not want such a huge effort, I think.  Some middle ground is possible.

There’s a lot of learning on the optimal rate of crime, some of it from John Donohue, my former colleague at Covington and Burling, but here’s a link that a comes up quickly:

http://sites.duke.edu/econ206_01_s2011/files/2012/05/11-Becker_Crime-and-Punishment_Lewis-Presentation.pdf.

+++

[1] Tun Yuan Hu, The Liquor Tax in the United States, 1791-1947: A History of the Internal Revenue Taxes Imposed on Distilled Spirits by the Federal Government (New York: Columbia University, Graduate School of Business 1950) at 73.

[2]Report to the Secretary of the Treasury of Findings of Fact and Law of the Informal Interdepartmental Committee Relative to Taxation and Control of Alcoholic Beverages, Supplement to Tax on Intoxicating Liquor, Hearings Before the Committee on Ways and Means, House of Representatives and the Committee on Finance, United States Senate, 73d Congress, Interim, 1st and 2d Sessions (Dec. 11-14, 1933), at 308-09.

[3] Hu, supra note 1, at 95.  Hu goes on:  “Mash seizures provides [sic] a fairly reliable index of illegal production.  It is significant that this series showed a drop of 65 percent between 1935 and 1938.”  Id. at 96.

[4] Harry G. Levine and Craig Reinarman, “From Prohibition to Regulation: Lessons from Alcohol Policy for Drug Policy” (March 10, 1991) available at http://www.drugtext.org/index.php?option=com_content&view=article&id=603:from-prohibition-to-regulation&catid=192:policy&Itemid=44&q=reinarman&lang=en.

[5] Statement of Luther Gulick, Director of the Institute of Public Administration, Tax on Intoxicating Liquor, Hearings Before the Committee on Ways and Means, House of Representatives and the Committee on Finance, United States Senate, 73d Congress, Interim, 1st and 2d Sessions (Dec. 11-14, 1933) at 147-48.

[6]Id. at 148.

[7] An hour-long CNBC report, “Marijuana Country: The Cannabis Boom,” shows and names a wounded Army combat veteran who, using Craigslist, transfers surplus medical marijuana tax-free, in sales portrayed as reciprocal donations, for “a third” of the legal retail price.  http://www.cnbc.com/live-tv/cnbc-originals/full-episode/marijuana-country-the-cannabis-boom/379637315796(beginningaround9:20mark)(firstairedonJanuary5,2015.)“I’mnotsellinganything. He’sjustgivingmesomemoney. AndI’mjustgivinghimsomecannabis.” (Around11:58mark.)

[8] Post-legalization of recreational marijuana, “King County [Seattle] Prosecutor Dan Satterberg says medical dispensaries live in a legal ‘gray area,’ and hasn’t brought many cases in part because King County juries simply won’t convict.”  Jonathan Martin, http://seattletimes.com/html/opinion/2025417951_jonathanmartincolumnmarijuana09xml.html?cmpid=2628,January8,2017.

[9]Cf. Peter Reuter, “Can tobacco control endgame analysis learn anything from the US experience with illegal drugs?” http://tobaccocontrol.bmj.com/content/22/suppl_1/i49.full.pdf (2013).

[10] So will the gray market, here meaning the market in goods that were once legal, but that don’t bear full tax.

[11] That term comes from “Concluding Thoughts” of Chapter Five of the Report.  This section in part supplements some of that discussion.

[12] Wilbur R. Miller, RevenuersandMoonshiners 8 (Chapel Hill: UNC Press 1991), at 6.  Modern-day tobacco companies have much more of an incentive to go after counterfeiters than to worry about cross-border tax-driven smuggling of products they have been paid for.

 

 

 

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Author: patoglesby

From 1982 to 1990, I worked in tax policy for Committees of the United States Congress. In recent years, I was Adjunct Lecturer at UNC-Chapel Hill's Business School and then Adjunct Professor at its Law School.

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