What Motivates Tax Compliance?

Abstract

In this paper, I review and assess what we have learned about what motivates individuals to pay -or to not pay -their legally due tax liabilities. I focus on three specific questions. First, what does theory say about what motivates tax compliance? Second, what does the evidence show? Third, how can government use these insights to improve compliance? I conclude with some suggestionsand some predictions -for future research. 356 ALM measure of the individual's constant relative risk aversion. Using the definitions of I C and I N in equations (1) and (2), the expected utility maximization generated by the solution to equation (3) can be solved for the optimum amount of reported income R*. 9 Now suppose that R* is calculated for specific, realistic values of the various parameters. For example, if t = 0.4, f = 2, p = 0.02 and e = 1, then the individual will optimally report no income. Very large values for relative risk aversion are required to generate compliance consistent with actual country experience. When e = 3, reported income is only 14% of true income; when e = 5, it is still only 44%; when e = 10, it is 71%; and e must exceed 30 for compliance to exceed 90%. Even if the probability of detection is as (unrealistically) high as 30% (with t = 0.4 and f = 2), relative risk aversion must exceed 7 to generate compliance over 90%. However, existing field evidence on the coefficient of relative risk aversion using a variety of approaches suggests that e ranges between 1 and 2, and may even be as low as 0 (Friend and Blume, 1975;Hansen and Singleton, 1983;Hall, 1988;Chetty, 2006;Gandelman and Hernandez-Murillo, 2013). Risk aversion must be abnormally large for behaviour to be even roughly comparable to actual observed choices, even in many developing countries with low levels of compliance.Admittedly, there are reasons why this simplistic analysis somewhat overstates the problem with the standard expected utility approach. 10 Consider the United States as an example. First, a standard feature of many individual income tax systems is that a third party (e.g. the individual's employer) reports the relevant part of an individual's taxable income to the tax authority (and often also withholds income taxes on this reported taxable income). This third-party information increases significantly the chances that an individual who underreports income on a filed return will be detected, especially in its combination with employer source-withholding. 11 Second, the 'official' IRS audit rate somewhat understates 'actual' IRS audit policy. In fact, the IRS conducts a range of audits, and for many types of audits, the actual rates are quite high. Third and relatedly, while overall audit rates are quite low, among certain income and occupation classes, they are more frequent. Fourth, the IRS conducts a wide range of audit-type activities, including line matching and requests for information, and these activities are much more frequent. 12 Finally, it is individual perceptions of audit rates that influence behaviour, rather than...

Audit State Dependent Taxpayer Compliance: Theory and Evidence From Colombia

“…Calculating elasticities at the baseline treatment values for the policy parameters (audit rate = 0.1, fine rate = 0.6, and tax rate = 0.3) and at means of the other variables ( Accumulated Unreported Income Rate , Income , Round ), the fine rate has a significant effect on compliance (using the results for 86 subjects), with an estimated elasticity of 0.41. For the audit rate, the estimated elasticities are 0.66 (for all subjects) and 0.51 (for 86 subjects), which are consistent with most other empirical estimates derived either from field data or laboratory data (Alm ). The tax rate estimate is not statistically different from 0 in any specification, and Income is also not statistically significant .…”

“…For a recent and comprehensive survey of the tax compliance literature, see Alm (). For earlier discussions of much of this work, see Cowell (), Andreoni, Erard, and Feinstein (), Slemrod and Yitzhaki (), Kirchler (), Alm (), and Hashimzade, Myles, and Tran‐Nam ().…”

Appeals to Social Norms and Taxpayer Compliance

“…The individual now chooses both the amount of income subject to employer withholding and the amount of self-reported income when maximizing expected value. 8 See Cowell (1990), Andreoni, Erard, and Feinstein (1998), Slemrod and Yitzhaki (2002), and Alm (2012Alm ( , 2019 for comprehensive surveys of this literature. 9 See Vossler andMcKee (2015, 2017) for more detailed discussions of these considerations, from which much of our framework is derived.…”

“…See Cowell (), Andreoni, Erard, and Feinstein (), Slemrod and Yitzhaki (), and Alm (, ) for comprehensive surveys of this literature.…”

Presumptive Taxation Methods: A Review of the Empirical Literature

“…For further details on the motives for voluntary tax compliance, see Alm (), who provides a comprehensive review about what motivates tax compliance, by discussing both theoretical and empirical literature.…”