Abstract
We examine whether tax audit regimes become more efficient if (i) there are audited financial statements and (ii) tax auditors have access to the internal statutory audit report revealing information about statutory audit adjustments. Our analysis is based on a standard tax compliance game that we extend to model the strategic interaction among a firm issuing financial and tax reports, a statutory auditor, and a tax auditor. We find that the efficiency effects of additional information depend on the strength of tax auditor incentives and the weight that firms place on book income. For high-powered tax auditor incentives, we obtain no information effect on our efficiency measures. For low-powered tax auditor incentives, we find an ambiguous effect, and for mediumpowered tax auditor incentives and firms that place a high weight on book income, tax audit efficiency increases if the tax auditor has access to additional information. In the latter case, we find that granting the tax auditor access to the internal statutory audit report increases firms' tax compliance, raises tax revenues, and decreases tax audit frequency.
Highlights
In many countries, tax administration budgets have declined significantly in recent years, and tax administrations, reduced their workforce
This paper investigates whether giving tax auditors access to audited financial statements and information about statutory audit adjustments increase the efficiency of the tax audit regime
Audit frequency still increases because of the higher audit probability for an uncorrected report b,t in regime 3b. Is it possible to simultaneously increase tax revenues and reduce tax audit frequency by providing the tax auditor with access to statutory audit adjustments? To examine this question, we integrate two novel features in a tax compliance game: In the first modification of the standard inspection game, the tax auditor can observe the financial statements that are already audited by a statutory auditor
Summary
Tax administration budgets have declined significantly in recent years, and tax administrations, reduced their workforce. For countries where tax auditors have medium-powered incentives and firms place a relatively high weight on book income, our analysis shows an unambiguously positive effect of information sharing between statutory and tax auditors on tax audit efficiency. In this case, the additional information can induce higher tax revenues and a lower tax audit frequency. The reason for the different effects of information about statutory audit adjustments is as follows: In case of a relatively high weight on book income, taxpayers who conduct upward earnings management of book income report their tax income truthfully because this reduces the risk that the statutory auditor corrects earnings management. The last section discusses the results and implications for future research
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