Understanding Spatial Variation in Tax Sheltering: The Role of Demographics, Ideology and Taxes

Taxpayers shelter income from taxation both through illegal evasion and legal avoidance. This tax sheltering creates a difference between a household’s actual income and what it reports to the tax authorities. While tax sheltering is a central concern for designing a tax system, the private nature of this behavior complicates evaluating the magnitude and determinants of such behavior. In this paper, we combine zip-code level data on reported income from the Internal Revenue Service (IRS) and the Census Bureau to examine three types of determinants of tax sheltering: (1) tax policy variables, including tax rates and the compliance generated third-party reporting of income; (2) political attitudes towards taxation; and (3) demographics. Our estimates suggest that higher tax rates increase the amount of tax sheltering; places with more self-employed people also shelter more income. In terms of political support, our results suggest that places with voters who are either more conservative or less supportive of tax increases actually shelter less income. We also find that minorities shelter more income from taxation and both older and more highly-educated households shelter less income from taxation. We thank Sandesh Dhungana for excellent research assistance. We appreciate comments from Alan Plumley, an anonymous referee, and participants at the conference “Understanding Place and the Economics of Space: Celebrating the Career of Roger Bolton.” All errors are solely our responsibility.