The effects of introducing withholding and third-party reporting on tax collections: Evidence from the U.S. state personal income tax

Abstract

This paper examines the impact of introducing withholding of the personal income tax by state governments in the U.S. We exploit the staggered adoption of withholding by individual states over the period 1948–1987 to construct event study estimates. We obtain a robust finding: Introducing withholding led to an immediate and permanent increase in income tax revenues by about 29 percent, holding tax rates constant. The result is consistent with the crucial role of withholding and third-party reporting in improving tax compliance. We consider several alternative explanations such as changes to the tax base and increases in enforcement activity but these explanations lack support. There is some evidence that non-filing substantially decreased following the introduction of withholding.