Tax Dynamics and Money Laundering: Simulating Policy Reforms in a Complex System

In: http://dspace.library.uu.nl/handle/1874/405095

Open Access

Abstract

International mobility of natural and legal persons and the application of new technologies, create more opportunities to avoid and evade taxes. To retain tax revenues, governments must provide an internationally attractive tax environment, making them compete with other governments. To counter this dynamic, new EU regulation is implemented, i.e. country-by-country reporting and the automatic exchange of information. This dissertation tests the effect of this legislation on tax evasion and avoidance, through an agent-based simulation model that incorporates the individual choices of natural and legal persons. The model estimates the European corporate tax losses in 2019 to be € 104.9 billion, which will increase to an annual loss of € 135.8 billion in 2029 under the current policy regime. Fully implementing CbCR and AEoI decreases the expected tax gap of 2029 by 16.4% to € 113.5 billion. As for the effectiveness of both policies, AEoI is demonstrated to be effective against tax evasion but not against tax avoidance, making the total tax losses € 134.0 billion (a merely 1.3% decline). The expected small effect of CbCR becomes much larger in the long run, it results in € 121.2 billion tax losses which represents a decline of 10.8%. The effectiveness of CbCR is explained by its positive effect on the tax morale of individuals. Given that compliance choices are affected by international differences between legal and tax systems and by information that agents receive from other agents that surround them, compliance must be governed responsively. The model shows that short-term effects of the aforementioned regulations increase the overall compliance level, but also indicates that long-term effects could counteract the intended goals. This dissertation provides a framework that improves tax compliance without fueling tax competition in the long term. The agent-based simulation shows that without responsive regulation, tax competition intensifies and the initial increase in compliance could reverse. A differentiated policy response could increase tax compliance by 6.54%, which translates into an annual increase of € 105 billion in EU tax revenues on income, profits, and capital gains. Attractive tax legislation frequently offers higher levels of financial secrecy, which obscure corporate ownership and the origin of revenues. Besides evading and avoiding taxes, such legislation also provides opportunities for criminal organizations to launder their criminal proceeds. Anti-money laundering regulation aims to mitigate the associated risks of financial secrecy and influence how criminal networks operate. Therefore, this dissertation evaluates the effect of anti-money laundering regulation on the network structures of criminal organizations. It is expected that the AML legislation makes money laundering more difficult and forces money launderers to both specialize and compete with others, which the analysis confirms due to significant changes in the structure of money laundering networks. An adverse effect of AML legislation is that it affects non-criminal organizations too. The importance of high quality corporate registers and transparently sharing this information internationally is an important basis for detecting and prosecuting money laundering.