Optimal Tax Policy Responses to Fake Residence and Tax Loopholes

Abstract

Wealthy individuals are highly mobile across jurisdictions due to differences in taxation. Since the pandemic, their mobility has been further promoted due to the expansion of cross-border remote working and the emergence of the so-called `digital nomads'. This poses a challenge to tax authorities, as low tax jurisdictions attract those high-skilled workers by enacting special tax regimes. This source of (external) avoidance --- prone to `fake residency' --- adds to the preexisting one caused by domestic loopholes. This is the scenario we analyze. Two jurisdictions engage in tax rate competition to maximize tax collection, while the home one also sets two types of administrative policies, each monitoring each margin of avoidance. We show that rising avoidance opportunities determine a trade-off: the optimal policy response results either in higher levels of external avoidance and lower levels of internal avoidance, or viceversa, depending on the source of expanded avoidance opportunities.

Keywords: Personal taxation, Fiscal residence fraud, Tax avoidance, Tax competition, Tax administration, Taxation of the rich.