Withholding matters: The impact of Act 32 on compliance with the earned income tax

Abstract

This paper examines Act 32 of the Pennsylvania state legislature which mandated the introduction of withholding for the local earned income tax (EIT) for all employees and the consolidation of a fragmented collection system to one collector per county effective January 1, 2012. The estimates I obtain suggest that the act resulted in increased compliance with the EIT of about 13 percent. A falsification exercise examining compliance with the property tax for the identical municipalities confirms that Act 32 did not impact the property tax. Both findings are robust to the inclusion of municipality fixed effects or municipality-specific time trends. • Pennsylvania reformed its earned income tax collection regime through Act 32 in 2008. • Earned income tax (EIT) compliance rose by 13 percent in the wake of these reforms. • Higher compliance resulted from a mandate that employers withhold tax for each worker. • Consolidation of tax collectors also plays a role in the increased compliance. • Counties with larger consolidation of collectors experienced larger increases.