Enforcing Wealth Taxes in the Developing World: Quasi-Experimental Evidence from Colombia

Juliana Londono-Velez

Juliana Londono-Velez

The rise in income and wealth inequality has spurred a renewed interest in progressive wealth taxation. However, experts have disputed whether rich countries like the U.S, could realistically enforce a wealth tax. The matter is even more critical in developing countries, where a happy few own most of the wealth while governments have a weak capacity to enforce taxes.

In “Enforcing Wealth Taxes in the Developing World: Quasi-Experimental Evidence from Colombia,” Professor Juliana Londoño-Vélez and her co-author Javier Avila-Mahecha fill this gap by leveraging quasi-experimental variation and data on personal wealth, offshoring, and tax evasion from Colombians’ tax returns and a government-designed program for disclosures of hidden wealth. To shed additional light on offshoring, the authors link the tax microdata with the leaked “Panama Papers,” which inform about Colombians offshoring to the country’s most relevant tax havens.

In the first part of the study, the authors estimate the prevalence, distribution, and nature of wealth tax evasion:

  • How big of a problem is tax evasion? There is substantial evasion: Colombia’s disclosure program revealed hidden wealth worth 1.73% of GDP, an order of magnitude more than a similar scheme in the U.S. recovered. Moreover, Colombians are three times more likely to evade than Scandinavians, with two-fifths of the wealthiest 0.01% admitting to hiding wealth.
  • Who evades? Wealth tax evasion is remarkably skewed: the wealthiest 0.01% of the distribution is 55 times more likely to dodge taxes than the top 5% as a whole.
  • How do people evade? More than 80% of tax evasion is achieved by hiding assets offshore, especially in neighboring tax havens like Panama. In all, the wealthiest evaders hide one-third of their fortune offshore.

In the second part of the study, the authors explore how wealth tax evasion responds to policies aiming to strengthen enforcement. In the field of Public Economics, the canonical framework for tax evasion models the decision of whether and how much to evade as a function of (i) the tax incentives, (ii) the perceived threat of detection, and (iii) the penalty for misreporting. Guided by this framework, the study exploits a series of exogenously-timed events to isolate effects along each of these components on tax compliance.

  • Can tax incentives encourage compliance in the short- and medium-term? A difference-in-difference approach compares wealthy individuals who did versus did not disclose under Colombia’s scheme. Tax compliance is persistent: three years after their revelation, disclosers report 49.2% more wealth. Because they also reveal the return of those assets, they end up paying 39% more income taxes. Since exposed wealth tax evasion concentrates at the top, the policy raised revenue collected from the wealthiest 1%, raising effective progressivity.
  • Does evasion respond to a credible threat of detection? Halfway through the disclosure scheme, the Panama Papers news story broke, exposing tax evaders named in the leak to government scrutiny. A difference-in-difference approach exploits the exogenous timing of this leak and compares wealth tax filers named or not in the leak before and after it occurred. The Panama Papers spooked Colombia’s elite to own up about their wealth: the leak caused a sixfold increase in the likelihood of disclosing any hidden wealth. Consistent with offshore tax evasion, disclosures of foreign assets increased by an even larger amount. Consequently, taxes paid by people named in the leak more than doubled.
  • Can evasion respond to the threat of jail? There is suggestive evidence that evasion responds to tougher sanctions, with a significant spike in disclosures six months after Colombia criminalized tax evasion for the first time in its history.

These results help reconcile the views of the wealth tax skeptics and enthusiasts regarding the feasibility of taxing wealth in a globalized world. On the one hand, offshore evasion is a serious threat to progressive wealth taxation, especially when the enforcement environment is weak. But, on the other hand, strengthening the enforcement regime can credibly improve wealth tax compliance, raise taxes from the wealthiest individuals, and safeguard the feasibility of progressive wealth taxation.