Abstract
Using a tax compliance game, we study whether the observability of the taxpayer’s financial accounting information and the statutory auditor’s report affects the tax compliance. We find that firms’ responses differ significantly between private and public firms. Private firms compensate for the reported signals by understating both book and tax valuations. We find that introducing the informative signals does not necessarily increase efficiency. In fact, for private firms, it may also lead to lower tax revenues. For public firms, however, the positive effect of using the informative signals on tax compliance is much more pronounced. The usage of audit reports in addition to financial accounting statements always increases tax revenues from public firms. Regarding changes in book-tax conformity, we find that higher book-tax conformity can lead to higher tax revenues from public firms; however, tax revenues from private firms decrease with higher book-tax conformity.
Highlights
Using a game-theoretical model, this paper investigates whether tax auditors should use additional information from financial accounting statements and statutory auditor reports to select their audit cases
We integrate two novel features in a tax reporting game: In the first modification of a standard inspection game, the tax auditor can observe the financial statements audited by a statutory auditor
The statutory auditor perfectly verifies potential overstatements but never corrects potential understatements. Firms can misreport both their book and their tax income. We extend this model by assuming that the tax auditor receives a report from the statutory auditor concerning deferred taxes
Summary
Using a game-theoretical model, this paper investigates whether tax auditors should use additional information from financial accounting statements and statutory auditor reports to select their audit cases. By using the information from financial accounting statements and the statutory auditor’s report, tax auditors could improve their audit efficiency, which should in turn result in higher tax compliance. In Mills and Sansing (2000), the tax auditor observes the (correct) financial statement valuation, which results in a higher audit probability for positive book-tax-differences. For private firms, the observability of an audit report may lead to lower tax revenues This result depends on the incentives of the tax auditor and the book-tax conformity. With low-powered tax auditor incentives, private firms have an incentive to present conforming tax and financial statements to avoid the signal This can result in lower tax revenues, in particular, if book-tax-conformity is high.
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