Unwilling or Unable to Cheat? Evidence from a Randomized Tax Audit Experiment in Denmark

Abstract

This paper analyzes a randomized tax enforcement experiment in Denmark. In the base year, a stratified and representative sample of over 40,000 individual income tax filers was selected for the experiment. Half of the tax filers were randomly selected to be thoroughly audited, while the rest were deliberately not audited. The following year, "threat-of-audit" letters were randomly assigned and sent to tax filers in both groups. Using comprehensive administrative tax data, we present four main findings. First, we find that the tax evasion rate is very small (0.3%) for income subject to third-party reporting, but substantial (37%) for self-reported income. Since 95% of all income is third-party reported, the overall evasion rate is very modest. Second, using bunching evidence around large and salient kink points of the nonlinear income tax schedule, we find that marginal tax rates have a positive impact on tax evasion, but that this effect is small in comparison to avoidance responses. Third, we find that prior audits substantially increase self-reported income, implying that individuals update their beliefs about detection probability based on experiencing an audit. Fourth, threat-of-audit letters also have a significant effect on self-reported income, and the size of this effect depends positively on the audit probability expressed in the letter. All these empirical results can be explained by extending the standard model of (rational) tax evasion to allow for the key distinction between self-reported and third-party reported incomes.

Taking the high road? Compliance with commuter tax allowances and the role of evasion spillovers

“…First, we examine the impact of socio-demographic variables on individual compliance. In line with previous studies (e.g., Kleven et al 2011), their impact on the evasion decision is rather limited. In contrast, variables that display the proximity of the taxpayer to a certain bracket threshold and, therefore, capture the opportunity and incentive to overreport, have strong effects on the compliance decision.…”

“…Throughout, we report average marginal effects that are computed as the average impact of partial or discrete changes over all observations (standard errors are adjusted accordingly). Generally, and in line with Kleven et al (2011), we find that most individual-specific variables are either insignificant or almost negligible in magnitude throughout.…”

“…While it is striking how self-reported items are subject to tax evasion, it is interesting to note that there are still many taxpayers not availing this easy opportunity for non-compliance (e.g., Kleven et al 2011 report non-compliance rates of purely self-reported income of around 40 percent). This paper adds one explanation to this observation showing that the individual evasion decision is crucially influenced by the compliance behavior of other taxpayers in one's vicinity.…”

“…Recent research concludes that not only psychological, moral or cultural aspects are responsible for preventing people from cheating but also the lack of opportunity to do so. Notably Kleven et al (2011), relying on a large scale audit experiment in Denmark, show that third-party reporting effectively inhibits people's possibility to cheat on their taxes while self-reported income is prone to be evaded (see Slemrod, Blumenthal and Christian 2001, for related evidence).…”

Tax Reforms and Intertemporal Shifting of Wage Income: Evidence from Danish Monthly Payroll Records

“…Danish tax return records have recently been used to provide some of the most compelling evidence of behavioral effects of taxation with respect to income responses, labor supply behavior and tax evasion (Chetty, Friedman, Olsen and Pistaferri, 2011;Kleven, Knudsen, Kreiner, Pedersen and Saez, 2011;Kleven, Landais, Saez and Schultz, 2013). Our empirical results complement these findings by providing novel evidence of tax avoidance in the form of intertemporal shifting of wage income where existing knowledge is limited.…”