Deterrence and beyond: Toward a kinder, gentler IRS

Deterrence and beyond: Toward a kinder, gentler IRS
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   DETERRENCE AND BEYOND: TOWARD A KINDER, GENTLER IRS James Alm, Betty Jackson, and Michael McKee* * University of Colorado at Boulder. We received many helpful comments from the participants of the Conference. Joel Slemrod, in particular, provided several suggestions that have materially improved both the content and the presentation of the paper. The Peat Marwick Main Foundation provided financial support for this research.   1 I. INTRODUCTION Traditional methods for increasing tax compliance have emphasized greater probabilities of detection and more severe penalties on evasion. However, because there are factors other than detection and punishment that affect individual compliance decisions, there are numerous compliance strategies available to government. For example, there is some evidence from psychology that rewards may be more effective than punishments for eliminating undesired behavior and for motivating desired behavior, so that positive inducements for honest taxpayers may be a useful tool for increasing tax compliance. Further, the recognition that taxes are necessary to finance government expenditures may play a significant role in many individuals' compliance decisions, and both the way in which taxes are spent and the manner in which these decisions are made may also affect compliance. There is also some theoretical speculation that taxpayer uncertainty about tax and enforcement policies can increase tax compliance. In the face of such uncertainty, it is argued that a rational individual may well increase his or her compliance. The existence of these and other factors suggests that government may be able to affect tax compliance through channels other than greater fines and audits. However, the impact of these various strategies is not known. 1  This paper reports the results of new laboratory experiments that investigate the effects of increased enforcement efforts and   2 positive inducements on tax compliance; the paper also summarizes the results of some previous experiments on the impacts of uncertainty and of the public sector decision process on compliance. 2  In the laboratory setting, subjects are faced with a typical compliance decision: they receive income, they pay taxes on income voluntarily reported, and they face a chance that underreported income will be detected and penalized. Various policies are introduced, and their impacts on compliance are investigated. For example, enforcement efforts are examined by changing the probability of detection and the penalty on unreported taxes, and positive inducements are introduced as various schemes by which honest taxpayers are rewarded, either as individuals or as a group. The experimental results indicate that each strategy can increase compliance, at least to a degree. Greater enforcement efforts raise compliance; however, given the likely range in which these tools can be varied, there are significant limits on the degree to which greater penalties or greater audit rates can be relied upon to improve compliance. Positive inducements can also be effective devices for inducing tax compliance. Compared to a no-reward case, tax compliance is significantly greater when compliant individuals are eligible for a lottery, when they receive an immediate, fixed reward, or when their future chances of detection decline; the introduction of a public good financed by the taxes of all individuals also significantly increases   3 compliance. Uncertain policies affect compliance, although not always in a positive way. When there is no apparent benefit from tax payments, uncertainty always increases individual compliance. However, when individuals receive an obvious benefit from their tax payments, uncertainty always has the opposite effect on compliance. Finally, the level of compliance increases when taxpayers perceive that they have greater input to the social process that allocates their tax payments. In short, government should pursue a variety of approaches that go beyond simple deterrence in order to achieve its desired degree of tax compliance. Section II discusses several factors that may enter the individual compliance decision. The experimental design is presented in section III. Section IV reports the results of the new and the previous experiments. Summary and conclusions are in section V. II. FACTORS IN THE COMPLIANCE DECISION This section discusses various factors that may explain why people pay taxes. These theories are used to motivate the various compliance strategies that government can pursue. The traditional economic explanation for tax compliance derives from the economics-of-crime approach of Becker (1968) that was first applied to compliance by Allingham and Sandmo (1972). 3  Here an individual is assumed to maximize the expected utility of   4 the evasion gamble, weighing the certain benefits of successful evasion against the risky prospect of detection and punishment. The sole factor that motivates any compliance is the fear of getting caught and penalized; in fact, if the expected penalty rate is less than the tax rate on reported income, then a rational individual will not report any income. There is some empirical evidence that compliance is affected by detection and punishment, at least to a degree. 4  However, most of this evidence is based on estimates of aggregate responses. Detailed information on individual responses to enforcement actions is seldom available. 5  Laboratory methods allow the generation of such information on individual responses. It is, however, important to recognize that detection and punishment cannot explain the compliance behavior of all individuals. The percentage of tax returns that are subject to detailed audit is quite small in most countries, and penalties are seldom more than a fraction of unpaid taxes. As argued by Graetz and Wilde (1985) and Skinner and Slemrod (1985), a purely economic analysis of the evasion gamble suggests that most individuals would evade if they were purely rational, since it is unlikely that cheaters would be caught and penalized. However, compliance in many countries remains relatively high. 6  Additional factors must play a role -- perhaps a dominant one -- in tax compliance. Another element in compliance decisions is suggested by fiscal exchange theory. Compliance may be motivated by the
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