Abstract
Abstract We study the effects of audits on long run compliance behavior using a random audit program covering more than 53,000 tax returns. We find that audits raise reported tax liabilities for five years after audit, effects are longer-lasting for more stable sources of income, and only individuals found to have made errors respond to audit. A total of 60%–65% of revenue from audit comes from the change in reporting behavior. Extending the standard model of rational tax evasion, we show that these results are best explained by information revealed by audits constraining future misreporting. Together these imply that more resources should be devoted to audits, audit targeting should account for reporting responses, and performing audits has additional value beyond merely threatening them.
Highlights
This paper investigated the dynamic effects of audits on income reported in subsequent tax returns
Understanding these effects is important both from the perspective of quantifying the returns to the tax authority from an audit, and for assessing the mechanisms by which audits might influence taxpayer behaviour. To answer this question we exploited a random audit program run by the UK tax authority (HMRC) under which an average of around 4,900 individuals are randomly selected for audit each year
We provided evidence of important dynamic effects, with the additional tax revenue over the five years post-audit equalling 1.5 times the direct revenue raised by audit
Summary
Audits are a widely used public policy tool for reducing corruption (Bobonis et al, 2016; Avis et al, 2018), improving public service delivery (Zamboni and Litschig, 2018; Lichand et al, 2019; Gerardino et al, 2020), ensuring environmental standards (Duflo et al, 2013, 2018), and improving tax compliance (Kleven et al, 2011; Pomeranz, 2015; Asatryan and Peichl, 2017; Bergolo et al, 2020; Sarin and Summers, 2020; among others). Using an event study strategy we show that these effects are driven by individuals who were found to be under-reporting, while there is no response for those found to have reported correctly These three results are explained by audits providing the tax authority with information about a taxpayer’s income at the time of audit. It allows us to rule out audits reducing tax reports, even for those who were found compliant, in contrast with results using alternative identification strategies (Gemmell and Ratto, 2012; Beer et al, 2019) These results are consistent with audits providing the tax authority with information at a point in time, which constrains future misreporting.
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