Economic Crime: Tax Offenses

The most serious federal tax crime is willful tax evasion, which carries a five-year maximum prison sentence and a maximum fine of $250,000 ($500,000 in the case of a corporation) plus costs of prosecution (26 U.S.C. § 7201 18 U.S.C. § 3571). As decisions in Spies v. United States, 317 U.S. 492 (1943), and United States v. Carlson (2000) clarify, this felony requires the government to prove three elements: (1) the existence of a tax deficiency; (2) willfulness; and (3) an affirmative act of evasion or affirmative attempt to evade. The "affirmative act" or "affirmative attempt" requirement distinguishes felony tax evasion from the misdemeanor offenses proscribed by 26 U.S.C. § 7203. Conduct like keeping double books or destroying records satisfies this affirmative act requirement. "Willful but passive neglect of the statutory duty may constitute the lesser offense, but to combine with it a willful and positive attempt to evade tax in any manner or to defeat it by any means lifts the offense to the degree of felony" (Spies, p. 499).

Less severe tax felonies cover other misconduct: willfully making false statements under penalty of perjury, 26 U.S.C. § 7206(1) (maximum three-year imprisonment, same maximum fines); willfully aiding or assisting the preparation of false tax documents, 26 U.S.C. § 7206(2) (same); and interfering with or offering bribes to federal tax officials, 26 U.S.C. § 7212(a) (same). Willful tax evasion is a felony, but willful failure to file a tax return is a misdemeanor only, as is the willful delivery of false statements (See 26 U.S.C. §§ 7203 and 7207).

The provisions of 26 U.S.C. § 3571 raise the maximum fine for all of these crimes, including possibly to twice the "gross gain" to the defendant (or twice the "gross loss" to the government, whichever is greater). Why the criminal sanction? Tax noncompliance differs from conduct that more typically is the target of the criminal law. These differences raise questions about the appropriate role for criminal tax enforcement.

One utilitarian perspective questions why, as a general matter, any criminal tax enforcement is appropriate. The focus here is on how best to achieve efficient deterrence. Tax noncompliance seems like the kind of conduct that appropriately severe civil penalties generally can deter. Tax evaders should respond to the prospect of harsh but purely financial penalties, because the point of tax noncompliance is financial gain, and because tax evaders at some point must have had enough financial resources to incur a tax problem in the first place. Tax evasion, moreover, is not the sort of impulsively sudden or passionate conduct that some skeptics doubt can be deterred. Under these conditions, some utilitarians advise government enforcers to use civil enforcement machinery, because the civil enforcement process and civil penalties both are cheaper to administer than are their criminal counterparts. The main conclusion here, which Kaplow and Shavell trace back to Bentham (p. 183), is that financial penalties should be imposed to the maximum extent feasible before turning to the criminal penalty of incarceration. (See also Polinsky and Shavell; Shavell, 1985, 1987.) This perspective is controversial, politically and otherwise, in its possible implication that the justice system should be more willing to imprison the poor than the wealthy. Calkins comments that "[a]ny suggestion that prison should be reserved for those who lack sufficient assets is a political non-starter that does not deserve serious discussion except as an interesting academic exercise" (p. 143, n.63). Utilitarians would agree that their analysis has limited relevance when federal law holds financial penalties to ineffectively low levels, as is true when fines cannot be set at more than double the actual gain from evasion and when the risk of prosecution is far less than 50 percent. In this situation—and especially when audits are uncommon—the threat of incarceration can be an important tax compliance incentive.

Retributivists begin with moral analysis rather than a utilitarian calculus, but here again the tax context has notable features. Social norms in support of paying taxes are weaker than the norms supporting many more traditional crimes. Tax sanctions compel nearly the entire adult population to undertake affirmative conduct that often is annoying, expensive, and popularly reviled. Conventional wisdom rates paying taxes with death. Even judges, the federal officials who ultimately enforce the tax code, sometime disparage the moral basis for tax obligations. The revered Judge Learned Hand, for instance, wrote in Newman v. Commissioner of Internal Revenue (159 F.2d 848 (2d Cir. 1947), cert. denied 331 U.S. 859 (1947)): "Over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant" (pp. 850–851). In the nation that venerates the Boston Tea Party, criminalizing the failure to pay taxes creates offenses that must get their moral core, not from the accepted badness of the failure itself, but rather from a condemnation of deliberate cheating on rules that govern everyone. From this perspective, the conventional wisdom about death and taxes reveals that most people accept taxes as something inevitable—something that most people dislike, true, but something that most people plan to pay. Retributivists focus on this mutual obligation and would tend to limit criminal prosecutions to cases where people shirk it with a blameworthy sense of wrongdoing. As with any sort of cheating, cases of tax evasion that are flagrant and outrageous provoke strong retributive reactions.

These utilitarian and retributive perspectives do fit with some aspects of U.S. criminal tax enforcement. Beginning with the utilitarian view, it is significant that U.S. criminal tax prosecutions are quite rare. During 1994–1998, for instance, the federal government prosecuted before district court judges on average only 846 people per year on tax law violations (DOJ, 1999, p. 24, Table A.3). (There seem to be many differing definitions of "tax law" and "prosecutions," so statistics of this sort must be treated with care and are most safely used only for general points of illustration.) Officials resort to criminal actions so rarely in part because they have a wide array of powerful civil enforcement remedies, including fines, interest, and property seizures.

Turning to the retributive perspective, a second striking feature of federal criminal tax policy is its demand for an unusually high level of culpability. Most federal tax crimes require proof that a defendant acted "willfully," which is a word of notorious ambiguity. (See generally Model Penal Code § 2.02 cmt. 10 n.47 (1985).) A recent Supreme Court attempt to define what "willfully" means in tax evasion cases is the decision in Cheek v. United States. Phrasing the matter in Model Penal Code terms (as the Cheek Court did not), the Cheek decision in essence held that "willfulness" requires knowledge by defendants that their actions violate the law. It is not enough to prove that these defendants acted recklessly in taking a risk that their actions might be illegal. Under Cheek's knowledge standard, a jury must acquit defendants who convince that jury that their beliefs about the tax laws are sincere—no matter how nutty or risky those beliefs might be. For tax crimes requiring "willful" conduct, then, the Cheek case established that ignorance of the law indeed is an excuse—even when that ignorance is objectively unreasonable. This high requirement of knowing culpability does contrast with the lower and more usual criminal law requirement of reckless culpability. (See Model Penal Code § 2.02(3); Wiley.) By judicial interpretation, then, tax crimes require the government to prove an unusually high level of culpability—more culpability than retributivists generally require for criminal liability.

Criminal tax prosecutions have declined in number and shifted in focus. The decline began in 1987 (see Syracuse University) and has been marked as a percentage of filed tax returns. The shift in enforcement focus stems in part from the decisions in the past two decades to enlarge the jurisdiction of the Criminal Investigation Division (CI) of the IRS. The Criminal Investigation Division has moved from investigating mainly pure tax crimes to participating in investigating other criminal violations in which tax components are related conduct: for example, money laundering, currency reporting, narcotics trafficking, and various frauds (including frauds in bankruptcy, gaming, health care, insurance, and telemarketing) (IRS, CI FY1999 Annual Report; see also Abrams). The general decline in the number of federal tax prosecutions thus is even sharper for traditional tax crimes like tax evasion. In 1998, for example, there were only 771 tax fraud prosecutions in the U.S., half the number from 1981 (TRAC at http://trac.syr.edu/tracirs/findings/aboutIRS/keyFindings.html).

A 1999 review of the Criminal Investigation Division by former judge and F.B.I. Director William H. Webster criticized this trend and recommended that the Criminal Investigation Division should focus its caseload more specifically on cases promoting voluntary compliance with the tax law—the historic and stated mission of the Criminal Investigation Division (Webster, 14). In the wake of the Webster Report's criticism, the IRS has defended its policies in documents entitled "Why Is IRS Criminal Investigation Involved in Narcotics Investigations?" and "Why Is IRS Criminal Investigation Involved in Financial Crimes?" The latter document explained that:

IRS is involved because IRS CI special agents conduct full, in-depth financial investigations which are intensely revealing about life style, habits, business transactions and business associates. Such complex financial investigations often lead right to the door of the drug kingpin, the fraudulent telemarketer, or corrupt individuals such as health care executives, political leaders, return preparers or even the local grocery store operator. (p. 1)

This rationale suggests that the Criminal Investigation Division will continue its past policies. It likewise suggests that federal "tax prosecution" may denote more a set of investigative techniques than a particular kind of crime that the Treasury Department has targeted.

The advent of the Federal Sentencing Guidelines in 1987 had a dramatic impact on Figure 2 SOURCE: http://www.trac.syr.edu/tracirs/findings/national/crimrefgph.html. sentencing for all federal crimes, including tax crimes. The guidelines set out a mandatory approach that greatly reduced the judicial discretion that previously had characterized federal sentencing. Under the cookbook approach of the guidelines, the crucial factor driving sentencing is the size of "tax loss"—the revenue loss that would have resulted had the offense been successfully completed, or the sum that the taxpayer owed but did not pay. (Tax payments after the crime has been committed do not reduce tax loss.) A graded table of tax losses sorts cases into twenty different categories. The most lenient category applies if the tax loss is less than $1700, for instance, in which case the guidelines dictate a prison sentence in the range of 0–6 months and permit probation instead of custody. In contrast, a tax loss of $80 million or more triggers the most severe treatment, which requires a mandatory prison sentence in the range of 63–78 months. The guidelines also adjust prison time for a range of related culpability factors. "Sophisticated concealment" or a previous criminal history, for instance, increase the prescribed sentencing ranges, while "acceptance of responsibility" leads to a shorter prison terms (U.S. Sentencing Guidelines Manual).

The U.S. Attorney's Manual section 6–4.340 states that "the Tax Division prefers that government counsel request the imposition of a jail sentence" in tax cases, but there are provisions for exceptions in "unusual and exceptional circumstances." In recent years, slightly more than half of those convicted of tax crimes actually do go to prison. At the same time, average federal tax crime penalties have remained roughly constant, Figure 3 SOURCE: http://www.trac.syr.edu/tracirs/findings/national/crimrefgph.html. at least at an aggregate level. The average jail sentence was twenty-two months in 1994 and 1995, twenty-six months in 1996 and 1997, and twenty-four months in 1998. The average fine was $8119 in 1994, $7140 in 1995, $9461 in 1996, $11,893 in 1997, and $7434 in 1998 (TRAC, at http://trac.syr.edu/tracirs/findings/98/index.html).