Combating overreporting of deductions in tax returns: prefilling and restricting the deductibility of expenditures

Martin Fochmann,Tobias Kölle,Michael Overesch,Frank Hechtner

doi:10.1007/s11573-020-01024-7

Abstract

We experimentally analyze three anti-tax-evasion mechanisms: (1) prefilling of deductions in tax returns, (2) restricting tax evasion opportunities by either disallowing or (3) limiting the deductibility of expenditures. We find that prefilling compared to blank forms reduces tax evasion. Cutting the number of tax evasion opportunities by disallowing the deductibility of expenditure items is an ineffective mechanism to combat tax evasion as individuals shift their tax evasion activities from the disallowed item to other non-restricted items. In contrast, our results suggest that just limiting the deductibility of expenditures avoids this evasion-shift-effect.

Highlights

Tax evasion continues to be a serious problem in society and rising media coverage of evasion scandals heightens the urgency to act
We examine the influence of three mechanisms applied to combat tax evasion behavior: (1) prefilling of deductions in tax returns, (2) restricting tax evasion opportunities by either disallowing the deductibility of expenditures or (3) limiting the deductibility of expenditures
Our study provides evidence to the literature that cutting the number of tax evasion opportunities by disallowing the deductibility of expenditure items is an ineffective mechanism to combat tax evasion

Summary

Introduction

Tax evasion continues to be a serious problem in society and rising media coverage of evasion scandals heightens the urgency to act. Initiated by the seminal papers of Becker (1968), Allingham and Sandmo (1972) and Yitzhaki (1974), a variety of papers have studied tax evasion and dishonest behavior.. Researchers focused primarily on tax evasion of income/earnings overreporting of deductions might be the only possibility to evade taxes for many people (such as typical wage earners) due to third party income reporting. We focus on deductions, in particular on how individuals report expenditures in a tax return. We examine the influence of three mechanisms applied to combat tax evasion behavior: (1) prefilling of deductions in tax returns, (2) restricting tax evasion opportunities by either disallowing the deductibility of expenditures or (3) limiting the deductibility of expenditures. We run an experiment in a controlled environment and analyze expenditure items that are substantial in real life

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Conclusion