Tax Havens: International Tax Avoidance and Evasion

Source: Jane G. Gravelle, Congressional Research Service, CRS Report for Congress, R40623, January 23, 2013

…Tax avoidance is sometimes used to refer to a legal reduction in taxes, whereas evasion refers to tax reductions that are illegal. Both types are discussed in this report, although the dividing line is not entirely clear. A multinational firm that constructs a factory in a low-tax jurisdiction rather than in the United States to take advantage of low foreign corporate tax rates is engaged in avoidance, whereas a U.S. citizen who sets up a secret bank account in the Caribbean and does not report the interest income is engaged in evasion. There are, however, many activities, particularly by corporations, that are often referred to as avoidance but could be classified as evasion. One example is transfer pricing, where firms charge low prices for sales to low-tax affiliates but pay high prices for purchases from them. If these prices, which are supposed to be at arms-length, are set at an artificial level, then this activity might be viewed by some as evasion, even if such pricing is not overturned in court because evidence to establish pricing is not available.

Most of the international tax reduction of individuals reflects evasion, and this amount has been estimated to range from about $40 billion to about $70 billion a year. This evasion occurs in part because the United States does not withhold tax on many types of passive income (such as interest) paid to foreign entities; if U.S. individuals can channel their investments through a foreign entity and do not report the holdings of these assets on their tax returns, they evade a tax that they are legally required to pay. In addition, individuals investing in foreign assets may not report income from them.

Corporate tax reductions arising from profit shifting have also been estimated. As discussed below, estimates of the revenue losses from corporate profit shifting vary substantially, ranging from about $10 billion to about $90 billion…