AUSTIN, Texas — The federal tax gap — money people and companies owe Uncle Sam but fail to pay on time — has climbed to historic highs: $696 billion in 2022 , according to the IRS. It's money that, if recouped, could fund infrastructure or education or pay down government debt.
One way to collect that money is through lawsuits prompted by corporate whistleblowers — often present or former employees who know a company's finances and expose its transgressions.
Federal law includes protections and rewards for tax whistleblowers. Washington, D.C., also has such measures, but at the state level, only New York does. Proposals have failed to pass in at least four other states. Could these laws be a relatively cheap and easy way for states to narrow their tax gaps?
New research from Texas McCombs suggests that the answer is yes. Aruhn Venkat , assistant professor of accounting, found that a 2010 New York whistleblower law deterred businesses from avoiding state income tax. It brought in an extra 7.7% in state tax revenue, amounting to $281 million a year.
Weighed against costs of enforcement, the state's return on investment exceeded 3,000% . "These whistleblower laws do work, and they're reasonably inexpensive from a government perspective," Venkat says.
Prodding Companies To Pay
The 2010 amendment to New York's False Claims Acts (FCA) awards whistleblowers up to 30% of delinquent taxes recovered. It protects them from retaliation, and it also makes companies pay their attorneys' fees.
In 2018, for example, Sprint paid $330 million to New York's attorney general to settle a tax fraud case, with $63 million going to the whistleblower.
Did such examples scare other companies into dodging fewer taxes? With Yoojin Lee from California State University, Shaphan Ng from Singapore Management University, and Terry Shevlin from the University of California-Irvine, Venkat looked at hundreds of companies subject to New York's FCA.
Using financial data for 2005-2015 — from five years before to five years after the law was passed — the researchers calculated the companies' effective tax rates: the shares of income they paid in state taxes. They compared those rates with those for similar companies in neighboring states. They found:
- On average, companies increased their state effective tax rates 7.1% after the law's passage, indicating lower tax avoidance.
- Rates for the most aggressive tax avoiders increased 34.9%.
Companies paid more in taxes, in part, because they reduced their use of several avoidance strategies, such as shifting money overseas or moving it to separate companies called special purpose entities.
The law had a double punch, the researchers found. Both general knowledge of the law and publicity around actual whistleblower lawsuits had deterrent effects on companies.
"They're complementary," Venkat says. "Just the passage of the law will deter state tax avoidance. So, you don't need only whistleblower events to deter firms."
Risks and Rewards
The researchers found a few downsides to the law. Companies with minimal business in New York lowered their numbers of establishments in the state after the FCA. But those that already had large presences did not reduce them.
"There could be a cost here, with firms just leaving," Venkat says. "But whatever is lost from a few firms leaving is probably made up by others reducing their tax avoidance."
The law doesn't always work out for whistleblowers, either, he adds. They run the risk that their claims may not be vindicated legally.
"It can still be a raw deal for employees who are whistleblowers, because they do end up being fired fairly often, even though that's illegal," he says. "There can be a cost for employees who do this."
" The Deterrence Effects of Tax Whistleblower Laws: Evidence from New York's False Claims Acts " is published inManagement Science.
