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.     

Social networks and occupational choice: The endogenous formation of attitudes and beliefs about tax compliance

The paper analyses the emergence of group-specific attitudes and beliefs about tax compliance when individuals interact in a social network. It develops a model in which taxpayers possess a range of individual characteristics – including attitude to risk, potential for success in self-employment, and the weight attached to the social custom for honesty – and make an occupational choice based on these characteristics. Occupations differ in the possibility for evading tax. The social network determines which taxpayers are linked, and information about auditing and compliance is transmitted at meetings between linked taxpayers. Using agent-based simulations, the analysis demonstrates how attitudes and beliefs endogenously emerge that differ across sub-groups of the population. Compliance behaviour is different across occupational groups, and this is reinforced by the development of group-specific attitudes and beliefs. Taxpayers self-select into occupations according to the degree of risk aversion, the subjective probability of audit is sustained above the objective probability, and the weight attached to the social custom differs across occupations. These factors combine to lead to compliance levels that differ across occupations.     

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.     

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 influence of tax authorities on the employment of tax practitioners: Empirical evidence from a survey and interview study

Tax practitioners play a crucial role in the degree of taxpayers’ compliance – a role that has increased as tax systems worldwide have become more complex. However, little is known about tax authorities’ impact on taxpayers’ decisions to employ tax practitioners. Based on earlier research on motivations to employ a tax practitioner and the extended slippery slope framework of tax compliance, we conducted two studies which provide some answers. A survey study – comprising a representative sample of 500 Austrian self-employed taxpayers – revealed that financial gain is not the most important reason to employ a tax practitioner but instead the motivation to avoid problems with the tax authorities. Related to that, we also find that taxpayers’ perception of tax authorities wielding coercive power motivates them to employ tax practitioners. In the interview study with 33 self-employed taxpayers and 30 tax auditors, taxpayers indicated that they sought to avoid contact with tax officers by employing tax practitioners. This finding was supported by tax officers who reported preferring interaction with tax practitioners over direct contact with taxpayers. The two studies point to the complex relationship between taxpayers, tax authorities and tax practitioners, and allow the drawing of theoretical and practical implications.     

Regulatory fit effects on perceived fiscal exchange and tax compliance

Paying taxes can be considered a contribution to the welfare of a society. But even though tax payments are redistributed to citizens in the form of public goods and services, taxpayers often do not perceive many benefits from paying taxes. Information campaigns about the use of taxes for financing public goods and services could increase taxpayers’ understanding of the importance of taxes, strengthen their perception of fiscal exchange and consequently also increase tax compliance. Two studies examined how fit between framing of information and taxpayers’ regulatory focus affects perceived fiscal exchange and tax compliance. Taxpayers should perceive the exchange between tax payments and provision of public goods and services as higher if information framing suits their regulatory focus. Study 1 supported this hypothesis for induced regulatory focus. Study 2 replicated the findings for chronic regulatory focus and further demonstrated that regulatory fit also affects tax compliance. The results provide further evidence for findings from previous studies concerning regulatory fit effects on tax attitudes and extend these findings to a context with low tax morale.     

Tax compliance depends on voice of taxpayers

Reducing the social distance between taxpayers and tax authorities boosts taxpayers’ acceptance of tax load and tax compliance. In the present experiment participants had the opportunity to pay their tax due either as one single compliance decision or as separate compliance decisions for each type of requested contribution (coined voice on contributions). In addition, contributions were either distributed according to a fixed scheme exogenously chosen, or participants had the possibility to change the distribution pattern (coined voice on distribution). Furthermore information about participants’ contributions was either clearly related to the tax context or related to government public expenditures (coined context). Besides analyzing the effect of voice and context on compliance, order of tax payments was controlled for in the analyses. Results show that having voice on tax contributions and on tax distribution leads to higher compliance. Moreover, compliance was higher in the context avoiding tax framing.     

AMBIGUITY ABOUT AUDIT PROBABILITY, TAX COMPLIANCE, AND TAXPAYER WELFARE

We show that an increase in uncertainty about the probability of being audited (ambiguity) increases tax compliance for ambiguity-averse taxpayers but reduces compliance for ambiguity lovers. Because experimental evidence reveals considerable heterogeneity with respect to ambiguity preferences, we conclude that fostering uncertainty about the probability of being audited may not be an effective policy for increasing taxpayer compliance. Moreover, because the tax authority can neither categorize nor screen taxpayers on the basis of their preferences for ambiguity, it is not likely to be either a useful or a desirable instrument for increasing taxpayer welfare. (JEL H26 , D81 )     

Informal sector taxes and equity: Evidence from presumptive taxation in Zimbabwe

Using a mixed‐methods approach, this article evaluates the equity implications of Zimbabwe's presumptive tax system, introduced in 2005 to raise revenue from the country's growing informal sector. The representative taxpayer method, which compares the hypothetical tax burdens of formal and informal sector taxpayers at varying income levels, shows that the presumptive tax regime undermines both vertical and horizontal equity. In addition, interviews with key informants from the tax authorities, other relevant organizations and informal sector operators were conducted to probe issues around collection, compliance and perceptions of fairness. The qualitative data suggest that weak enforcement, with more visible informal activities bearing the brunt of the tax burden, and selective (and sometimes politically motivated) application of the legislation, compromise equity further.     

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.     

Framing of information on the use of public finances, regulatory fit of recipients and tax compliance

Information campaigns to increase tax compliance could be framed in different ways. They can either highlight the potential gains when tax compliance is high, or the potential losses when compliance is low. According to regulatory focus theory, such framing should be most effective when it is congruent with the promotion or prevention focus of its recipients. Two studies confirmed the hypothesized interaction effects between recipients’ regulatory focus and framing of information campaigns, with tax compliance being highest under conditions of regulatory fit. To address taxpayers effectively, information campaigns by tax authorities should consider the positive and negative framing of information, and the moderating effect of recipients’ regulatory focus.     

Misperception of chance and loss repair: On the dynamics of tax compliance

Previous experimental studies on tax behavior have been particularly concerned with determining the absolute effect of detection rate and punishment on tax filing, leading to mixed results. In this paper, we shed some additional light on the effectiveness of audit probability and sanctions by drawing upon a dynamic setting with particular focus on the time lag between audits. Our results showed that tax compliance decreased immediately after a random audit, suggesting that subjects were prone to misperception of chance. Sanctions decreased compliance to a lesser extent; they were, however, associated with the tendency of subjects to repair their losses by increasing their capital stock.     

Mental accounting of income tax and value added tax among self-employed business owners

Mental accounting describes a series of cognitive operations that help organize financial activities and facilitate money management. Self-employed taxpayers who make use of a separate mental account for future income tax payments or collected value added tax (VAT) might find it easier to declare their taxes correctly than taxpayers who do not. This study used a questionnaire to investigate whether self-employed taxpayers (N = 350) use mental accounting to manage their income tax and VAT obligations, whether mental accounting relates to tax knowledge, business and personality characteristics, and to what extent mental accounting is related to intended tax behavior. Our results reveal that some taxpayers mentally segregate taxes from turnover (segregators) while others do not (integrators). We found small differences in mental accounting between income taxes and VAT. Moreover, confirmatory factor analyses suggested that tax knowledge and mental accounting are distinct constructs. Segregation of taxes was related to lower impulsivity and more positive attitudes toward taxation. Individuals who stated they segregate taxes due from turnover more often claimed to run financially prosperous businesses. Mental accounting was not related to intentions of evading taxes, but individuals with higher mental accounting scores reported more pronounced levels of tax planning. While our research design does not allow drawing causal inferences, these findings could suggest that increasing self-employed taxpayers’ ability to organize their financial activities might be a promising strategy to strengthen the competitiveness of their businesses.     

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.     

Tax differentiation,lobbying, and welfare

To what extent a taxing authority should be granted the power to impose different tax schedules to different groups of taxpayers? Although the policy maker aims at maximizing social welfare, her tax policy may be distorted by the lobbying activity of taxpayers. In this political environment we characterize the conditions under which social welfare can be increased by restricting the set of tax instruments available to the policy maker; i.e., the scope of tax differentiation. We show that full differentiation is more costly, in terms of welfare distortions, when the lobbies are asymmetric in size, while minimal differentiation is more costly when the tax bases are asymmetric across different groups.     

Intention to pay taxes or to avoid them: The impact of social value orientation

Economic factors such as audit rates and fines have shown inconsistent effects on tax payments, suggesting that they are not sufficient to explain tax compliance. Moreover, the tax compliance rate is surprisingly higher than what the standard economic model would predict. In the last fifteen years, literature aimed at solving this so called “puzzle of compliance” has increased and pointed out several factors that could possibly explain tax compliance processes, e.g., knowledge of the tax laws, trust toward the political system, as well as personal or social norms. The studies presented here examined the impact of social value orientation on tax morale and intention to avoid/evade taxes. Social value orientation was examined both as a chronic personal orientation (Studies 1 and 2) and as a contextual factor made salient by experimental manipulations (Study 3). The results are supportive of a relationship between social value orientation and measures of tax compliance. Furthermore, results of Study 3 provided evidence for a causal effect of social value orientation on intended tax non-compliance. The effect of social value orientation on intended tax non-compliance was mediated by tax morale (Studies 2 and 3). Results are discussed with reference to their potential practical applications.     

AUDIT STATE DEPENDENT TAXPAYER COMPLIANCE: THEORY AND EVIDENCE FROM COLOMBIA

We develop and analyze a dynamic model of individual taxpayer compliance choice that predicts “audit state dependent taxpayer compliance,” by distinguishing between forward-looking versus myopic versus naïve behavior. We then test experimentally the audit state dependent model by reporting the results from the first tax compliance experiment run in Colombia. We find that subjects' compliance rates increase with greater enforcement. We also find more novel results: fine rates should be increased after an audit, and “nudging” myopic individuals toward reporting a constant rather than a fluctuating proportion of income would benefit both the taxpayer and the tax authority.(JEL H26, C91)     

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.     

Commitment to tax compliance: Timing effect on willingness to evade

Experimental and empirical literature on individual decision-making has shown a remarkable difference between planning and ongoing decisions: when asked to plan their actions, people overweight events with low probability; on the contrary, in ongoing decisions, they tend to ignore them. We report on a laboratory experiment designed to explore the presence of this decisional inconsistency in taxpayers’ behavior, by means of a commitment system for compliance. In line with the overweighting of events with small probabilities (i.e. fiscal audits), we find that planning induces the majority of people not only to adopt a mechanism of commitment to tax compliance, but also to actually comply.     

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.