Tax evasion is a problem that concerns both developing and developed countries, however to different extent: in developing countries tax evasion practices are extremely widespread, while in developed countries evasion rates are substantially lower, but still existent. Some of the reasons that facilitate tax- evasive behavior are weakness of tax administration, low tax education and cultural issues.
There are a few methods that people use to engage in tax evasion. Usually two or more schemes are used together, since proceeds from one scheme serves as a prerequisite for another. These schemes for hiding taxes are quite effective, almost risk free and result in large money savings.
Scheme 1 of tax evasion that is illustrated in Figure 1 replaces items in income statement that are subjects to high taxes , with items with low or no taxes. Replacement is made based on contract between the client and a “fake” firm. Under the contract a fake firm is supposed to render some service to the. The client transfers cash to the bank account of fake firm client in exchange for false report on provision of service, but receives this cash back on the same day paying certain “commission” (up to 5% of transferred cash) to the management of the fake firm. Thus “black cash” becomes available for paying for transactions that are not recorded anywhere.
The second scheme of tax evasion uses the cash generated from the first scheme for employee remuneration. Company management reports considerably lower salary, than he/she actually pays to the employees. Besides legal payroll the employees are remunerated by the black cash. For instance, we compare two cases: firm paying 100 GEL (Georgian Lari) to the employee legally and 200 GEL illegally (See Figure 2) versus paying all 300 GEL in a legal way.
From the first case personal income tax (PIT) payable to the budget is 12 GEL and social tax (ST) 20 GEL, contrary to the second case when tax expenses are PIT-36 GEL and ST-60 GEL. In the first case employer receives signed receipt from the employee that the wage paid to him/her was only 100 GEL that can be presented at the tax authority. Total return from evasion is 24+40=64 GEL and the state budget and the specialized state funds lose the same amount.
Second scheme uses yield generated from the first scheme to operate second scheme and decrease total costs associated with business operations. However it should be pointed out that these tax evasion schemes are particularly designed for small businesses, since large businesses find it difficult to control “black” and “white” part of their businesses.