Firms as tax shelters: The disguise of personal expenses as business expenses erodes tax revenues

By how much and how do individuals who control firms blur the lines between personal and business expenses to avoid taxes? By disguising personal expenditures as business inputs, firm owners avoid paying taxes at the distribution of  business income, either as wages or dividends, and on VAT. This strategy also inflates firm costs, which reduces taxable profits. While sometimes regarded as a minor economic issue compared to other forms of tax evasion, a new study reveals that using firms  as tax-free consumption vehicles is widespread among business owner-managers and has important impacts on government revenue loss and income inequality.

Drawing on data from an electronic invoicing program in Portugal (e-Fatura), David Leite empirically estimate the proportion of personal expenditures shifted to firms and the impacts on government revenue loss and inequality.

Key findings:

• Individuals who control firms shift 36% of their monthly personal expenditures to firms and 31% of their household expenditures.
• The government revenue losses due to consumption through the firm amount to 1% of GDP.
• This practice is most common among owner-managers of small closely held firms, which make up over 80% of firms in the economy. But it is widespread among business managers across the whole income distribution.
• Expenditures most shifted to firms are on the border between business and personal consumption (e.g., retail trade, hotels and restaurants), as opposed to expenditures harder to justify as business-related (e.g. private education or non-essential health services).
• The pattern of business expenditures is affected by personal consumption motives. Business expenditures on hotels and restaurants increase 9.8% in the birthday month of the owner-manager and 6.1% in the birthday month of the owner-manager’s spouse (who does not work in the firm).

AUTHORS

• David Leite, Paris School of Economics, World Inequality Lab, Statistics Portugal

MEDIA CONTACT

• Alice Fauvel, Communications Manager, press[at]wid.world