Audit Rates Research Articles

Learning in experiments: Dynamic interaction of policy variables designed to deter tax evasion

While neoclassical economic theory sheds insight into the way that audit rates and penalty rates interact when individuals decide to declare income for taxation, it predicts far lower levels of compliance than observed levels of compliance. This paper analyses experimental responses to explore a dynamic interaction between audit and penalty rates as individuals learn how to comply with taxation. It compares the responses of subjects in experiments with responses that are predicted when individuals rely on an adaptive learning process (that offers information feedback about decision payoffs). This comparison suggests that learning is an important consideration when explaining differences between predicted and observed levels of tax compliance.

THE IMPACT OF AUDIT RATE, PERCEIVED PROBABILITY OF AUDIT ON TAX COMPLIANCE DECISION: A Laboratory Experiment Study)

This study aims to provide empirical evidence that audit rate and perceived probability of audit have impact on tax compliance. This study used a laboratory experiment to test the impact of economic factor (audit rate) and psychology factor (perceived probability of audit) on tax compliance decision. 78 participants were involved in this experiment from the master of science and doctoral program and accounting magister of FEB UGM Yogyakarta. This experiment used multilevel treatment experiment design and standard of fieldwork media for software. The results provide empirical evidence that audit rate and perceived probability of audit have significant relationship with tax compliance decision. Audit rate has indirectly related to tax compliance decisions by perceived probability of audit. We propose a model that is intended to clarify the mechanism through perceived probability of audit impact to tax compliance decisions. The result highlights the importance of obtaining a proper understanding of these factors for developing effective policies with the aim of increasing the level of compliance, and indicate that audit rate should be implemented to improve tax accuration report using perceived robability of audit by tax payer.

The Impact of Tax Knowledge and Budget Spending Influence on Tax Compliance

We conduct a computerized economic laboratory experiment to infer the causal effect of two non-economic determinants on tax compliance. We find strong evidence that higher compliance in tax systems with low power of authorities can be achieved by increasing trust in authorities in form of knowledge about tax expenditures and the possibility for taxpayers to actively influence budget spending. However, in tax systems with high power of authorities we do not find any effect due to the threatening impact of high audit rates already enforcing a high level of compliance. To clearly identify the importance of these effects on tax compliance we take account of how the power of authorities is perceived by taxpayers when making decisions under risk and uncertainty in reporting tax liability. The perceived power of authorities is measured by taxpayer’s individual risk attitudes. Further, we control for taxpayer’s general attitude towards paying taxes and the overall orientation towards tax authorities via the motivational posture “tax commitment” (Braithwaite 2003). Individual risk aversion as elicited by lottery choices in a multiple price list format is correlated with tax compliance, reflecting the acknowledgement of the power of tax authorities. Opposed to this we do not find any evidence that a positive orientation towards tax authorities is positively related to compliance.

The Indirect Effects of Auditing Taxpayers

Empirical studies suggest that the effects of tax audits are not only in terms of recovered unpaid tax (direct effect) but there are also indirect effects in terms of future better compliance that tend to outweigh the direct effect. However, current policy decisions on the allocation of investigation resources across different groups of taxpayers generally neglect the indirect effects, generating a potential resource misallocation issue. With the aim to clarify a possible mechanism through which the indirect effects work, the authors model tax compliance as a social norm and show that taxpayers’ interdependencies introduce a multiplier effect to an increase in the audit rate.

America’s unreported economy: measuring the size, growth and determinants of income tax evasion in the U.S.

This study empirically investigates the extent of noncompliance with the tax code and examines the determinants of federal income tax evasion in the U.S. Employing a refined version of Feige’s (Staff Papers, International Monetary Fund 33(4):768–881, 1986, 1989) General Currency Ratio (GCR) model to estimate a time series of unreported income as our measure of tax evasion, we find that 18–23% of total reportable income may not properly be reported to the IRS. This gives rise to a 2009 “tax gap” in the range of $390–$540 billion. As regards the determinants of tax noncompliance, we find that federal income tax evasion is an increasing function of the average effective federal income tax rate, the unemployment rate, the nominal interest rate, and per capita real GDP, and a decreasing function of the IRS audit rate. Despite important refinements of the traditional currency ratio approach for estimating the aggregate size and growth of unreported economies, we conclude that the sensitivity of the results to different benchmarks, imperfect data sources and alternative specifying assumptions precludes obtaining results of sufficient accuracy and reliability to serve as effective policy guides.

The experience of the eleanor bradley fellow

The Eleanor Bradley Fellowship was established to enable specialist trainees from the UK to gain valuable obstetric experience in a resource limited setting. Set up in 2008, by the RCOG...

Regulatory enforcement with competitive endogenous audit mechanisms

This article adds to the regulatory compliance literature through the theoretical development and experimental testing of two endogenous audit mechanisms that use contemporaneous relative comparisons, based on disclosed information or imperfect signals of compliance effort, to generate a compliance competition among agents. This type of audit mechanism has some advantages over the more widely studied dynamic audit mechanisms that condition an agent's audit probability on past compliance, and provides an alternative explanation for the stylized fact, in many settings, that most agents are compliant most of the time even though audit rates and expected penalties are low.

An Empirical Analysis of Determinants of Recent Federal Personal Income Tax Evasion in the U.S.

Unaccounted for currency in die U.S. has been argued to reflect die presence of widespread income tax evasion. In turn, income tax evasion is especially problematic in this era of large government budget deficits and growing national debts which have led to debt crises. This empirical study seeks to identify determinants of recent federal personal income tax evasion in the U.S. using the most recent tax evasion data available, data that run through 2008 and are derived from the General Currency Ratio Model and measured in the form of the ratio of unreported AGI (adjusted gross income) to reported AGI. The empirical estimates find that personal income tax evasion is an increasing function of the maximum marginal federal personal income tax rate, the interest rate yield on three year Treasury notes, per capita real income, and a dummy variable for the years in which the second war in Iraq was conducted, while being a decreasing function of the Tax Reform Act of 1986, the ratio of the tax free interest rate yield on high grade municipals to the taxable interest rate yield on ten year Treasury notes, the audit rate by IRS (Internal Revenue Service) personnel, and the average IRS penalty on detected unreported income. Thus, among other things, this study finds that more aggressive IRS policies are effective tools in the war against personal income tax evasion.

Tax Compliance as an Evolutionary Coordination Game: An Agent-Based Approach

Tax reporting compliance by small business owners is modeled in an agent-based framework using concepts and methods based on evolutionary dynamics. A business owner’s ‘‘fitness’’ is a function of net after tax (and post-audit) income. Business owners exhibit heterogeneous tax morale and compliance propensity following four stochastically assigned behavioral ‘‘archetypes’’: Honest, Strategic, Defiant, and Random. The model is calibrated to observations from laboratory experiments and taxpayer random audits. The calibrated model is used to simulate evolutionary changes in a static population of 10,000 small business owners. A simulation using realistic parameters for the probability of audit and penalty rate finds that after fifteen time periods, the initial number of Honest business owners declines by approximately one-third and are displaced by proprietors having either Defiant or Strategic compliance behaviors.

Early complications of total hip and knee replacement: a comparison of outcomes in a regional orthopaedic hospital and two independent treatment centres

There is anecdotal evidence of poorer outcomes from prosthetic joint replacement performed in independent treatment centres but very few comparative studies. We compared the early re-operation, dislocation, re-admission, major wound infection and audit rates of 880 total hip (THA) and 874 total knee (TKA) arthroplasties carried out at a regional orthopaedic hospital (Avon Orthopaedic Centre; AOC) with 368 THAs and 365 TKAs from an NHS (WGH) and 67 THAs and 86 TKAs from a private hospital (CNH) independent treatment centre. Early re-operation rates were 9% at CNH, 1.4% at WGH and 0.6% at AOC after THA and 8% at CNH, 1.9% at WGH and 1% at AOC after TKA. After THA, dislocation rates after THA were 6% at CNH and 1.8% at both WGH and AOC. Re-admission rates were 13% at CNH, 0.6% at WGH and 1.2% at AOC. Major wound problems were 20% at CNH, 3.8% at WGH and 0.4% at AOC after THA and 19% at CNH, 1.9% at WGH and AOC (1.1%) after TKA. After TKA, re-admission rates from CNH were 13%, 1% at WGH and 1.1% at AOC. AOC and WGH audited their outcomes. None were available from CNH. Results and audit from independent treatment centres are variable and patients should be warned of this before undergoing treatment at them.

Targeting occupations with varying reputations to increase tax revenue

If the government's goal is to raise tax revenue in a cost-effective manner, which (if any) occupation categories could be targeted with a higher probability of an audit to yield increased revenue? Looking beyond mere opportunity to evade (e.g., self-employment) and starting from the premise that taxpayers in certain occupations evade more than others, the issue is whether these taxpayers respond to a change in the audit rate. Theory suggests that compliance increases in response to higher audit rates; the occupations with the higher evaders could therefore be targeted. This theory is tested by drawing a connection between occupation, reputation, and tax compliance. We assume that taxpayers in occupations with high need for reputation respond to a lower extent to increased tax audits than taxpayers whose achievement does not depend on reputation. The results support the effectiveness of raising tax revenue by targeting specific occupations, non-managers, with a higher probability of an audit.

Spatiality and Persistence in U.S. Individual Income Tax Compliance

This paper examines the twin issues of spatiality and persistence in the individual income tax evasion decision. The issue of persistence arises through accumulated learning over time; spati- ality arises for several reasons , including the exchange of informa- tion between taxpayers , the social norm of tax compliance , and the difficulties faced by individuals with dynamic stochastic decision problems like tax evasion. The paper uses state-level, time-series, cross-section data for the years 1979 to 1997 to estimate the factors that affect per return evasion of the individual income tax. The esti- mation methods incorporate both spatial dependence and dynamic considerations ; they also consider the potential endogeneity of the audit rate. The empirical results provide strong and robust support for both spatiality and persistence in tax evasion. The results also show a large deterrent effect from higher audit rates.

Income tax crime and government responses in the United States 1998‐2007

PurposeThe most recent IRS estimate puts the individual tax gap at $245 billion per year. This study seeks to develop and review performance measures for the seven most important IRS programs aimed at reducing the tax gap.Design/methodology/approachThe study develops and analyzes performance measures for the last ten years. The performance measures include discovery rates, penalty rates, penalty dollars, abatement rates, abatement dollars, collection activity rates, and criminal enforcement activities (number of special agents, investigations, referrals, indictments, sentences, and length of sentences).FindingsThe results are mixed regarding changes in performance measures. There was almost no change in audit rates and increases in other IRS discovery programs. There was a steady decrease in civil penalties for the first seven years followed by increases in latest three years. There were decreases in abatements for most penalties, a dramatic decrease in seizures, and significant increases in liens and levies. There were noteworthy decreases in the number of special agents and criminal investigations. The relatively small number of criminal investigation activities is surprising given the amount of the tax gap.Originality/valueThis study examines all major programs aimed at the individual tax gap.

Getting the word out: Enforcement information dissemination and compliance behavior

The question for the tax authority is how individuals become aware of enforcement effort. To be an effective tool in reducing tax evasion taxpayers must be aware of the current audit and penalty regime. We use laboratory experiments to examine the compliance impact of types of information dissemination regarding audit frequency and results. The information includes “official” information disseminated by the tax authority, and “unofficial”, or informal, communications among taxpayers. Our results indicate that the effect of the type of post-audit information is conditional on whether the taxpayer is well informed of the audit rate prior to filing. We find that the tax authority would be served by pre-announcing audit rates credibly and by emphasizing the previous period audit frequency in annual reporting of enforcement effort.

Do Individuals Comply on Income Not Reported by Their Employer?

Individuals with income not reported to the tax authority by a third party (e.g., the self-employed, those earning tips) may be less likely to be detected evading taxes relative to the case in which their income is subject to third-party reporting. However, their compliance responses—to changes in the proportion of income that is reported to the tax authority, to changes in audit and tax rates, etc.—are largely unknown, in part because of the difficulty in obtaining information on individual choices in these situations. The authors use experimental methods to examine individual income tax compliance in settings where individuals differ in the portion of their income that is ``matched'' (reported to the tax authority via third-party information) versus ``nonmatched'' (not fully reported to the tax authority). The results indicate that individuals who have relatively more nonmatched income exhibit significantly lower tax compliance rates than individuals who earn relatively less nonmatched income.

Controlling tax evasion fluctuations

We incorporate the behaviour of tax evasion into the standard two-dimensional Ising model and augment it by providing policy-makers with the opportunity to curb tax evasion via an appropriate enforcement mechanism. We find that tax evasion may vary greatly over time if no measures of control are taken. Furthermore, we show that even minimal audit rates of a tax authority may help to alleviate this problem substantially. Similar results are observed for other network structures.

Criminal Investigation Enforcement Activities and Taxpayer Noncompliance

This article tests empirically whether measurable activities of the IRS Criminal Investigation Division (CI) affect taxpayer compliance. The analysis is based on a state-level cross-section for the time period 1988 through 2001. First, it finds that CI activities have a measurable and significant effect on voluntary compliance. Second, it concludes that the mix of sentenced cases (for tax and money laundering violations) is not a significant determinant of tax compliance. Third, it finds that incarceration and probation (rather than fines) have the most influence on taxpayers. Simulations using the estimated models show that the direct effect of doubling the audit rate on assessed tax collections (reported amounts and additional taxes and penalties) is $21.7 billion. Doubling CI tax and money laundering sentences is forecast to increase assessed collections by $16.0 billion. It estimates the general deterrence or spillover effects from either audit or CI activities to be approximately 95 percent.

Why do people pay taxes? Prospect theory versus expected utility theory

Using actual probabilities of audit and penalty rates, the return on evasion is 91–98%. So why do not most of us evade? Existing analysis, based on expected utility theory (EUT) is unable to explain this. Furthermore, and contrary to intuition and the bulk of evidence, EUT predicts that evasion should be decreasing in the tax rate (Yitzhaki puzzle). We apply Tversky and Kahneman’s [Tversky, A., Kahneman, D., 1992. Advances in prospect theory: cumulative representation of uncertainty. Journal of Risk and Uncertainty 5, 297–323] cumulative prospect theory to tax evasion. We show that prospect theory provides a much more satisfactory account of tax evasion including an explanation of the Yitzhaki puzzle. This also provides independent confirmation of prospect theory.

Do Individuals Comply on Income not Reported by Their Employer?

Individuals (e.g., the self-employed and those earning casual wages such as tips) with income not reported to the tax authority by a third party may be less likely to be detected evading taxes relative to the case in which their income is subject to third-party reporting. However, their compliance responses - to changes in the proportion of income that is reported to the tax authority, to changes in audit and tax rates, and so on - are largely unknown, in part because of the difficulty in obtaining information on individual choices in these situations. We use experimental methods to examine individual income tax compliance in settings where individuals differ in the portion of their income that is “matched†(or reported to the tax authority via third-party information) versus “nonmatched†(or not fully reported to the tax authority). Our results indicate that individuals who have relatively more non-matched income exhibit significantly lower tax compliance rates than individuals who earn relatively less non-matched income. Our results also indicate that higher income levels, higher tax rates, and lower audit rates lead to increased tax evasion, but with responses that vary depending upon the proportion of matched versus non-matched income.

Tax compliance and obedience to authority at home and in the lab: A new experimental approach

In most experimental studies of tax evasion, participants are instructed that they may report any amount of income from zero up to the amount they actually earned or received. This amounts to an invitation to gamble. In contrast, real-world tax authorities unambiguously demand compliance. We develop two new settings for conducting tax experiments. Both involve an explicit demand for compliance. Thus, we can determine whether knowing that the experimental authority would regard evasion as wrongful disobedience will influence compliance decisions. We demonstrate that simply telling people that they are required to pay a “participation fee” analogous to a tax produces remarkably high compliance rates and less sensitivity to changes in economic variables than in the earlier experimental literature using invitation-to-gamble language. This suggests that many people pay taxes despite the financial attraction of non-compliance because they are strongly inclined towards obeying authority. Furthermore, we show that giving participants a week to make their reporting decisions at home without an authority figure physically present overcomes the inclination to obey for some people, significantly lowering compliance rates. However, the majority still complies, even after the audit rate falls from 25% to 1%, which would make non-compliance extremely attractive if it were viewed only as a simple matter of risk and expected return.