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.     

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.     

Targeting occupations with varying reputations to increase tax revenue

If the government's goal is to raise tax revenue in a cost-effective manner, which (if any) occupation categories could be targeted with a higher probability of an audit to yield increased revenue? Looking beyond mere opportunity to evade (e.g., self-employment) and starting from the premise that taxpayers in certain occupations evade more than others, the issue is whether these taxpayers respond to a change in the audit rate. Theory suggests that compliance increases in response to higher audit rates; the occupations with the higher evaders could therefore be targeted. This theory is tested by drawing a connection between occupation, reputation, and tax compliance. We assume that taxpayers in occupations with high need for reputation respond to a lower extent to increased tax audits than taxpayers whose achievement does not depend on reputation. The results support the effectiveness of raising tax revenue by targeting specific occupations, non-managers, with a higher probability of an audit.     

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.     

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)     

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.     

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.     

Uncertainty resolution in tax experiments: Why waiting for an audit increases compliance

Tax compliance in a between-subjects experiment was higher when the uncertainty about the occurrence of an audit was not resolved until three weeks after participants had filed their tax returns than in a control treatment with immediate uncertainty resolution. Results have important implications for experimental tax research where providing immediate feedback whether participants are audited is common practice.     

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.     

The effects of income source,context, and income level on tax compliance decisions in a dynamic experiment

This study employs a laboratory experiment to explore the joint effect of income source (earned versus endowed) and decision context (tax versus nontax) on tax compliance behavior. During the experiment, subjects faced various income levels and made multiple reporting decisions. The results indicate that overall compliance is not significantly affected by the interaction of income source and context. However, this joint effect influences the relationship between income level and compliance and how compliance behavior evolves over time. In both cases, the treatment group with earned income in a tax context displays behavior that is distinct from the other three groups.     

An examination of the impact of subject selection on hypothetical and self-reported taxpayer noncompliance

Understanding taxpayer noncompliance involves the use of government reported statistics as well as taxpayer self-reported data. Both sets of data are subject to biases, but both have information to offer tax researchers. The present study addressed whether self-reported compliance rates and hypothetical reporting decisions correspond to government reported compliance rates and whether self-reported compliance rates correspond to hypothetical reporting decisions. The relationships were found to be positively correlated, but the results were influenced by the method of sample selection for the subjects. The findings of this study provide additional insight to help researchers cautiously interpret results from behavioral tax studies.     

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.     

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.     

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.     

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.     

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.     

The Good, the Bad, and the Regulator: An Experimental Test of Two Conditional Audit Schemes

Conditional audit rules are designed to achieve regulatory compliance with fewer inspections than required by random auditing. A regulator places individuals into audit pools that differ in probability of audit or severity of fine and specifies transition rules between pools. Future pool assignment is conditional on current audit results. We conduct an experiment to compare two specific schemes—Harrington's Past-Compliance Targeting and Friesen's Optimal Targeting—against random auditing. We find a production possibility frontier between compliance and minimizing inspections. Optimal targeting generates the lowest inspection rates as predicted, but random auditing the highest compliance. Past-compliance targeting is intermediate.     

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.     

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 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.