The role of information aggregators in tax compliance

Abstract

Fifty-six percent of the US taxpaying population uses a paid tax preparer, but the effect of these tax preparation services on tax compliance is not well understood. Although governments conceal the algorithms they use to determine which taxpayers to audit, tax preparation firms with large client bases may be able to infer these algorithms and therefore offer strategic advice to taxpayers. This paper formalizes this role, using a simple asymmetric information model where agents can purchase information about the government’s enforcement rules. In a competitive market for tax preparation services, demand for tax preparers is selective and increases in taxpayer income. Moreover, the presence of tax preparers always reduces compliance when tax preparers have perfect information. Perhaps surprisingly, if the demand for strategic advice is high enough, the government can mitigate evasion by revealing full information about its audit rule. Alternatively, when the tax preparers have imperfect information about the audit rule, if the top income within an audit class is low enough, the government can utilize tax preparer firms to increase compliance by influencing the audit information available to these firms.