The effects of official and unofficial information on tax compliance

The administration of tax policy has shifted its focus from enforcement to complementary instruments aimed at creating a social norm of tax compliance. In this paper we provide an analysis of the effects of information regarding the past degree of tax evasion at the social level on the current individual tax compliance behavior. We build an experiment where subjects declare their income after receiving either a communication of the average tax evasion rate (“official information”) or a private message from a group of randomly matched peers about their tax behavior (“unofficial information”). We use the experimental data to estimate a dynamic econometric model of tax evasion and find three main results. First, tax compliance is very persistent, but less so in the presence of information. Second, the higher the officially communicated past tax evasion rate, the higher the degree of persistence: former evaders are more likely to evade again (and evade more), and former compliant individuals are more likely to comply again (and, when evading, evade less). Third, when an unofficial communication of past evasion (compliance) from all their peers is received, both former evaders and compliant individuals are more likely to evade (comply) again.     

Honesty or dishonesty of taxpayer communications in an enforcement regime

In many settings the true likelihood of capture when engaging in an illegal activity, such as tax evasion, is not well known to an individual. “Official” statements from the tax administration regarding enforcement effort provide some information. In addition, “informal”, or “unofficial”, communication among taxpayers can supplement these official announcements, but individuals do not know with certainty whether such unofficial information is honest (or accurate) versus dishonest (or inaccurate). We examine the truthfulness of an individual’s revelation of unofficial information to other individuals, along with the factors that affect any revelation, focusing on the intrinsic motivations for revelations. Our experimental design allows us to examine the type and the honesty of messages that an individual chooses to send to other individuals regarding their own audit outcome and their own compliance behavior. Our results indicate that most individuals send accurate messages about their own audit outcomes and their own compliance behaviors. Nevertheless, many individuals are also systematically dishonest about being audited; that is, we observe a significant tendency for individuals to claim that they were audited when they were not. We also observe a strong interaction between individuals’ audit outcomes and their compliance behaviors, so that individuals who engaged in tax evasion and who were audited were more truthful in their communications than those whose tax evasion went undetected.     

An agent-based model of network effects on tax compliance and evasion

Agent-based models are flexible analytical tools suitable for exploring and understanding complex systems such as tax compliance and evasion. The agent-based model created in this research builds upon two other agent-based models of tax evasion, the Korobow et al., 2007, Hokamp and Pickhardt, 2010 models. The model utilizes their rules for taxpayer behavior and apprehension of tax evaders in order to test the effects of network topologies in the propagation of evasive behavior. Findings include that network structures have a significant impact on the dynamics of tax compliance, demonstrating that taxpayers are more likely to declare all their income in networks with higher levels of centrality across the agents, especially when faced with large penalties proportional to their incomes. These results suggest that network structures should be chosen selectively when modeling tax compliance, as different topologies yield different results. Additionally, this research analyzed the special case of a power law distribution and found that targeting highly interconnected individuals resulted in a lower mean gross tax rate than targeting disconnected individuals, due to the penalties inflating the mean gross tax rate in the latter case.     

The consequences of different strategies for measuring tax evasion behavior

A critical review of existing measures of tax evasion suggests the need for innovative measurement strategies. Toward this end, a new method for documenting cases of individual tax evasion without compromising confidentiality is described. Results of an investigation in The Netherlands indicated negligible correspondence between scores on this measure and self-reports of tax evasion behavior. This outcome is particularly disturbing since the self-reports were obtained under conditions that should have maximized their veridicality. Additional analyses indicated that different sets of attitudes, norms and personality variables are correlated with admitted tax evasion and with patterns of actual behavior. The implications for future research are discussed.     

Income tax evasion dynamics: Evidence from an agent-based econophysics model

We analyze income tax evasion dynamics in a standard model of statistical mechanics, the Ising model of ferromagnetism. However, in contrast to previous research, we use an inhomogeneous multi-dimensional Ising model where the local degrees of freedom (agents) are subject to a specific social temperature and coupled to external fields which govern their social behavior. This new modeling frame allows for analyzing large societies of four different and interacting agent types. As a second novelty, our model may reproduce results from agent-based models that incorporate standard Allingham and Sandmo tax evasion features as well as results from existing two-dimensional Ising based tax evasion models. In this way, such kind of models may become more relevant and useful in economics as well as social psychology. We finally use our model for analyzing income tax evasion dynamics under different enforcement scenarios and point to some policy implications that may also be of interest for psychological research on tax compliance.     

Legalism and creativity: tax non-compliance in the eyes of the economic elite

This paper analyzes elite tax compliance from a sociological perspective in order to examine how different tax behaviors are justified or how they embody different taxpayers’ subjectivities. Drawing from the case of Chile and using a qualitative approach based on 32 interviews conducted with members of the economic elite, it is argued that forms of non-compliance -such as evasion and avoidance- are grounded in different ‘repertoires of evaluation’ while denoting a plurality of distinctions and criteria of evaluation which relate to the legal culture in which the tax system operates. Findings show that legalism -a literal conception of the rules- does not always favor tax compliance and that it may even go against the purpose of tax collection when a creative use of the law prevails. Furthermore, legalism and creativity allow for the main justifications for challenging tax payment as well as the perceptions and beliefs that underlie the everyday relationship between taxpayers and the state to be understood.     

Work performance and tax compliance in flat and progressive tax systems

Different tax systems, and their impact on work motivation and tax compliance are significant issues in contemporary political and economic debates. The proportional feature of a flat tax system is assumed to lead to higher performance, while the fairness of the redistributive progressive tax system is assumed to result in higher tax compliance. However, empirical findings on the topic are inconclusive. Both work performance and tax compliance under different tax systems were examined in an experiment, with special attention devoted to the effect of a change in tax systems. A flat tax system was supposed to induce greater work performance, whereas a progressive tax system was expected to increase tax compliance based on fairness perceptions, allowing for the opposite effect due to higher complexity. Furthermore, it was assumed that performance and tax payments would be influenced by motives of self-interest. The design included 20 rounds with a real-effort task in each round, determining participants’ experimental income. Participants (N = 191) made decisions about their tax payments from round-to-round in four different experimental conditions: (1) a flat tax system, (2) a progressive tax system, (3) starting with a flat and changing to a progressive, and (4) starting with a progressive and changing to a flat tax system. Results indicate higher work performance in a progressive system. However, a change from a progressive tax system to a flat system led to increased tax compliance.     

Measuring and explaining tax evasion: Improving self-reports using the crosswise model

Due to its sensitive nature, tax compliance is difficult to study empirically, and valid information on tax evasion is rare. More specifically, when directly asked on surveys, respondents are likely to underreport their evasion behavior. Such invalid responses not only bias prevalence estimates but may also obscure associations with individual predictors. To generate more valid estimates of tax evasion, we used a new method of data collection for sensitive questions, the crosswise model (CM). The CM is conceptually based on the randomized response technique (RRT), but due to its advanced design, it is better suited for large surveys than classical RRTs. In an experimental online survey, we compared the CM (N = 862) to standard direct questioning (DQ; N = 305). First, our results showed that the CM was able to elicit a higher proportion of self-stigmatizing reports of tax evasion by increasing privacy in the data collection process. Second, on average, we found stronger effects of our predictor variables on tax evasion in the CM condition compared with the DQ condition such that an egoistic personality and the opportunity for tax evasion predicted actual tax evasion only in the CM condition.     

Misperceptions of social norms about tax compliance: From theory to intervention

Taxpayers may estimate others’ acceptance of tax evasion as being greater than their own. This self–other discrepancy in tax ethics could undermine people’s tax compliance as they conform to the misperceived social norm. Feedback about the self–other discrepancy could correct the misperception and improve compliance. This approach was first tested in a scenario study with 64 students. Respondents showed the expected self–other discrepancy in tax ethics and feedback about the finding increased their hypothetical compliance. Further results showed that the effect was due to the intervention improving the perception of others’ tax ethics, as expected. Study 2, a field experiment with 1500 Australian taxpayers, replicated the self–other discrepancy and provided taxpayers with information about the result. Compared to control groups, the feedback did not affect work-related expenses claims but significantly reduced other deduction claims.     

The slippery slope framework on tax compliance: An attempt to formalization

Kirchler, Hoelzl, and Wahl (2008) presented with the so-called ‘slippery slope’ framework a new approach to understand tax compliance. The slippery slope approach supposes two routes to tax compliance: deterrence of tax evasion by audits and fines on the one hand, and building a trusting relationship with taxpayers by services and support on the other hand. In this paper, the slippery slope framework is formalized by assuming two groups of taxpayers: compliance-minded and evasion-minded persons. Defining reaction functions for persons of both groups with respect to coercive and persuasive power instruments of tax authorities, the typical slippery slope picture emerges that characterises the authorities’ work. As a consequence, both groups of policy tools are considered necessary to generate tax compliance. In addition to that, it is shown that coercive and persuasive power may be substitutes or complements to each other, depending of the parameters of the taxpayers’ reaction functions. As a further crucial determinant of tax compliance, the behaviour of the fellow citizens with respect to taxpaying is identified.     

Reciprocal relationships in tax compliance decisions

Reciprocity considerations are important to the tax compliance problem as they may explain the global dynamics of tax evasion, beyond individual tax evasion decisions, toward a downward or upward spiral. To provide evidence on reciprocity in tax compliance decisions, we have conducted a laboratory experiment in which we introduced two types of inequities. The first type of inequity is called vertical, because it refers to inequities introduced by the government when it sets different fiscal parameters for identical taxpayers, while the second type of inequity is called horizontal because it refers to the fact that taxpayers may differ in tax compliance decisions. In this setting, taxpayers may react to a disadvantageous or advantageous inequity through negative or positive reciprocal behaviors, respectively. Our results support the existence of negative and positive reciprocity in both vertical and horizontal cases. When both inequities come into play and may induce reciprocal behaviors in opposite directions, the horizontal always dominates the vertical.     

The distinct role of group-central and group-peripheral norms in taxpaying behaviour

In recent years, a social identity approach has been used to help understand why people do or do not pay tax [see Taylor, 2003; Wenzel, M., 2002. The impact of outcome orientation and justice concerns on tax compliance: the role of taxpayers’ identity. Journal of Applied Psychology 87, 629–645; Wenzel, M., 2004. An analysis of norm processes in tax compliance. Journal of Economic Psychology 25, 213–228; Wenzel, M., 2005. Misperception of social norms about tax compliance: from theory to intervention. Journal of Economic Psychology 26, 862–883; Wenzel, M., 2007. The multiplicity of taxpayer identities and their implications for tax ethics. Law & Policy 29, 31–50]. This research, which has focused almost exclusively on national identity, indicates that the more people identify with a group, the more likely they are to adhere to its tax norms and values. However, conformity to group norms may be more nuanced than this, and depend on (a) the meaning or content of the identity in question [e.g., Turner, J.C., 1999. Some current themes in research on social identity and self-categorization theories. In: Ellemers, N., Spears, R., Doojse, B. (Eds.), Social Identity: Context, Commitment, Content. Blackwell, Oxford, pp. 6–34] and (b) whether the norms and values are central or peripheral to the content of that identity. In line with this idea, two studies explored whether the concept and act of taxpaying are more central to what it means to be a member of one's nation than of one's occupational group. Both studies confirm this expectation. Importantly, the findings also suggest that although occupational groups have different norms and values in relation to pre-tax behaviours (e.g., how to deal with extra income), these too can be peripheral to what it means to a group member. If norms are peripheral to identity content, conformity to such norms may be independent of group identification.     

The backfiring effect of auditing on tax compliance

Using country-level data from 2003–2014, we examine the association between auditing level (measured as number of verification actions taken by tax authorities per 100 taxpayers in each country) and tax compliance (measured as business executives’ perception of tax evasion). Our hypothesis is that compliance increases until a certain auditing level is reached, and decreases beyond that level (i.e., an elevated auditing level backfires). In line with our expectation, the results of a series of tests indicate that there is a U-shaped association between auditing and tax evasion. We discuss how a potential backfiring effect may depend on the extent to which compliance is voluntary.     

Behavioral dynamics of tax evasion – A survey

Since the 1950s (Schmölders, 1959) it is well known that behavioral aspects have an influence on tax evasion or tax compliance. In particular, interactions among the various entities involved in the taxation process (e.g. taxpayers, law makers, tax practitioners, tax authorities, etc.), and the dynamics that these interactions may generate, seem to play an important role for the actual level of tax compliance. However, the mainstream neoclassical approach to tax evasion (Allingham & Sandmo, 1972) cannot account for such interactions and dynamics. Therefore, during the last two decades new approaches (e.g. lab experiments, agent-based modeling, etc.) have been developed with a view to model how behavioral dynamics may foster or prevent tax evasion. In addition, empirical evidence has been generated that supports a role for such interaction dynamics. In this contribution we survey the main developments in this research area and provide some suggestions for further research.     

Correlates of tax evasion

Tax evasion has increased in the United States. Estimates of evasion indicate that the amount of federal income taxes evaded equals the federal deficit. Thus, controlling tax evasion should be a major concern of future tax policy decisions. This study analyzes the effects of 18 variables that might affect tax evasion. Specifically, the variables were used as independent variables in discriminant analyses to determine their relationship to tax evasion. The results indicated that the variables affect different types of tax evasion differently, and that all variables do not significantly influence tax evasion. Policy implications are presented based on these results.     

Learning in experiments: Dynamic interaction of policy variables designed to deter tax evasion

While neoclassical economic theory sheds insight into the way that audit rates and penalty rates interact when individuals decide to declare income for taxation, it predicts far lower levels of compliance than observed levels of compliance. This paper analyses experimental responses to explore a dynamic interaction between audit and penalty rates as individuals learn how to comply with taxation. It compares the responses of subjects in experiments with responses that are predicted when individuals rely on an adaptive learning process (that offers information feedback about decision payoffs). This comparison suggests that learning is an important consideration when explaining differences between predicted and observed levels of tax compliance.     

Can strategic uncertainty help deter tax evasion? An experiment on auditing rules

This paper adds to the economic-psychological research on tax compliance by experimentally testing a simple auditing rule that induces strategic uncertainty among taxpayers. Under this rule, termed the bounded rule, taxpayers are informed of the maximum number of audits by a tax authority, so that the audit probability depends on the joint decisions among the taxpayers. We compare the bounded rule to the widely studied flat-rate rule, where taxpayers are informed that they will be audited with a constant probability. The experimental evidence shows that, as theoretically predicted, the bounded rule induces the same level of compliance as the flat-rate rule when strategic uncertainty is low, and a higher level of compliance when strategic uncertainty is high. The bounded rule also induces distinctive tax evasion dynamics compared to the flat-rate rule. The results suggest that increasing the level of strategic uncertainty among taxpayers could be an effective device to deter tax evasion.     

An application of attribution and equity theories to tax evasion behavior

Traditional economic theory often has been utilized in an attempt to explain tax evasion behavior. Although economic consequences are important factors in the understanding of tax evasion behavior, they alone do not appear adequate to describe and predict the phenomenon. The results of two experiments which apply two social psychological theories, attribution theory and equity theory, to tax evasion judgments are reported. In the first experiment, the effects of personal need and degree of societal consensus were investigated. Both variables significantly affected recommended penalty judgments. In the second experiment, the effects of societal need and distinctiveness were studied. Neither societal need nor distinctiveness affected recommended penalty judgments. However, a significant interaction effect was found concerning subjects' behavioral intentions to evade. The present research suggests that both attribution theory and equity theory may be helpful in formulating hypotheses and enhancing our understanding of tax evasion behavior.     

Power,justice, and trust: A moderated mediation analysis of tax compliance among Ethiopian business owners

We explored the moderating roles of legitimate and coercive power held by the tax authority in the relationship between procedural justice, trust in the tax authority, and voluntary tax compliance. Drawing from fairness heuristic theory and the slippery slope framework of tax compliance, we predicted that procedural justice fosters voluntary tax compliance, particularly when legitimate power of the tax authority is low and when coercive power of the authority is high. Moreover, we predicted that these interactive effects are mediated by (cognition-based) trust. Finally, we predicted that coercive power of the tax authority is positively related with enforced tax compliance. The results of a field study among Ethiopian business owners supported most predictions. This research is among the first to integrate social–psychological and deterrence-related factors to understand tax compliance behavior in a developing country.     

Empathy,sympathy, and tax compliance

This paper examines the effect of “empathy” and “sympathy” on tax compliance. We run a series of laboratory experiments in which we observe the subjects’ decisions in a series of one-shot Tax Compliance Games presented at once and with no immediate feedback. Importantly, we employ methods to identify subjects’ sympathy, such as the Davis Empathic Concern Scale and questions about frequency of prosocial behaviors; we also use priming in order to promote subjects’ empathy. Our results suggest that the presence of sympathy in most cases encourages more tax compliance. Our results also suggest that priming to elicit empathy also has a positive impact on tax compliance. These results support the inclusion of noneconomic factors in the analysis of tax compliance behavior.