Posted by Carlos Scartascini
Tax evasion is endemic in many countries. In particular, some developing countries do not collect even half of what they should if taxpayers complied with the written letter of the law.2/ In these countries, enforcement mechanisms are weak, tax-collecting authorities are held in low esteem, and courts may not enforce the rules. This problem is sometimes compounded at the local level because the capacity to enforce the law is even lower. As local governments are given more and more expenditure responsibilities and central governments struggle to finance the budget, the need to increase revenues becomes more pressing for subnational authorities.
In order to understand why people pay or do not pay taxes we need to analyze the underlying motives behind compliance. The literature has been prolific on this issue. People tend to comply with the law when the expected utility or gains from complying surpass those from evading. In this computation, taxpayers compare the benefit from pocketing the money that should have been sent to the authorities versus the potential losses from being caught and having to pay interest and fines. Of course, in the same way that people do not steal or cross a traffic light inappropriately―even if the chances of being caught are zero―social norms and morals also play a role in people’s decisions to pay taxes. Taxpayers tend to comply if they believe it is the right thing to do. Otherwise, compliance would be much lower. This belief tends to be reinforced if people think that the taxes being imposed on them are fair and equitable.
How Can Compliance Be Improved?
Plenty of specific solutions have been offered in the literature and many more have been tried by public authorities. Increasing and better focused enforcement, improving the collection and management of information, reducing the costs of complying with the law (such as filling complicated forms), providing incentives for those who comply, and modifying tax bases and rates are some of the obvious examples.
In some countries, the regular avenues for boosting tax compliance are largely dead-ends: the capacity to enforce the law by engaging in a massive audit campaign or taking large numbers of people to court is relatively limited, and the scope for making legislative changes or reducing transaction costs still further may be limited. In this context, efforts to apply the principles of behavioral economics to the beliefs and moral values that people attach to paying taxes have proved to be a worthwhile initiative.
There is plenty of evidence from developed countries that messages from the tax authorities affect taxpayers’ behavior and increase compliance. For example, Coleman (1996, 2007) found a significant effect for taxpayers in Minnesota: the mean increase in federal-declared taxable income for the group receiving a letter that corrects the false perception of many taxpayers that cheating on taxes was common was $2,390. Wenzel (2002, 2007) found similar results in Australia and more recently, Kleven et al. (2011) found positive effects on self-reported income in Denmark, and Fellner, et al (2013) in Austria. The Behavioral Insights Team (or “Nudge Unit”) at the UK Treasury has systematized and popularized the use of behavioral economics in various government applications.
The evidence for developing countries—where trust in government is lower and tax evasion is higher—is less abundant, but some interesting work has been started. In a recent working paper, Castro and Scartascini (2013) explore the impact of the use of messages for affecting taxpayers’ compliance by conducting a large-scale field experiment in Argentina.
The experiment covered approximately 23,000 individuals who were subject to a property tax in an Argentinean municipality (Junin). The tax was levied upon individuals according to the size of the property and the services they receive from the local government, such as street lighting, trash collection, and street cleaning. The taxpayers were randomly divided into four groups. One of the groups received no special treatment in their tax bills (the control group); the other three groups received various messages in their bills. The “deterrence” message stated “Did you know that if you do not pay the CVP (property tax) on time for a debt of AR$ 1,000 you will have to disburse AR$ 268 in arrears at the end of the year and the municipality can take administrative and legal action?” and included a picture of a gavel. The idea of this message was to alert taxpayers to the penalties and other actions that the municipality could take to enforce the law. The “fairness” message highlighted the investment activities carried out by the municipality in the previous six months to reduce the perception of waste and inefficiency: “In the first 6 months of this year, CVP’s collection contributed to placing 28 new streetlights, water connections in 29 streets, and sewerage networks in 21 blocks”. Finally, the “equity” message attempted to reduce the perception of universal evasion: “Did you know that only 30 percent of taxpayers do not pay the CVP? What about you?” In every case, and following the suggestions of a focus group, the test was accompanied by pictures that attempted to reinforce the message.
The messages were designed to affect people’s beliefs about deterrence (enforcement and fines), equity (other taxpayers’ behavior), and fairness (the use of resources by the government). The results indicate that introducing messages in the tax bill may be a useful instrument for affecting taxpayers’ behavior because those taxpayers who received the messages tended to behave differently than those who didn’t.
The results of the experiment indicated that the most effective message was the one focused on deterrence that listed the fines and other actions at the disposal of the municipality in the case of noncompliance. More precisely, tax compliance among the taxpayers who received this message increased by almost 5 percentage points with respect to the control group (which is equivalent to reducing tax evasion by more than 10 percent).
Interestingly, the study found that not everybody reacts to the messages in the same way. Whether taxpayers have a track record of compliance, their personal wealth, and the level of provision of public goods seem to influence the effectiveness of the messages. For example, people with lower levels of wealth seem to react more to the messages than those with higher levels of wealth (who may not even react at all). This suggests that message targeting may be advisable; messages could be tailored for each individual taxpayer (or groups of taxpayers) according to their actual levels of tax-related debt.
Also, some of the messages had a negative effect on some people, which led to lower levels of compliance. For example, some taxpayers who used to comply stopped doing so after they learned that the actual rate of compliance in the population was lower than they had thought. This evidence provides further support for targeting the messages instead of sending common messages or running universal campaigns through newspapers or other media outlets.
Conclusion
There are several important policy implications. First, behavioral economics has important applications in the design of public policies for taxation and other fields. Second, the cost of applying such methods in the fight against tax evasion―by inserting appropriate messages in tax invoices and other documents issued by the authorities―is extremely low. Choosing policies according to their benefits and costs is a feature (as indicated by Sandmo [2005]) sometimes ignored both by the academic literature and policymakers. Third, the messages should be appropriately designed to have a positive effect on taxpayers. Fourth, “universal” policies may backfire, as positive and negative behavioral responses cancel each other out. Therefore, policies (particularly “nudges”) should be tailored to taxpayers’ types. Finally, it is important to consider how to make any of the compliance (and revenue) gains permanent. On the one hand, any efforts to change beliefs through the use of messages should be accompanied by equivalent actions by government authorities such as stepping up enforcement. On the other hand, complementary mechanisms should be introduced to facilitate compliance among debtors who are willing to pay, and to reinforce the positive effect of complying for those taxpayers who changed their behavior.
References
Castro, L., and Scartascini, C. (2013). “Tax Compliance and Enforcement in the Pampas.” Evidence from a Field Experiment. IDB Working Paper No. 472. Washington, DC: Inter-American Development
Bank. Coleman, S. (1996). The Minnesota Income Tax Compliance Experiment: State Tax Results.” MPRA Paper 4827. Munich, Germany: Munich University Library.
Coleman, S. (2007). “The Minnesota Income Tax Compliance Experiment: Replication of the Social Norms Experiment.” MPRA Paper 5820. Munich, Germany: Munich University Library.
Corbacho, A., V. Fretes Cibils, and E. Lora, editors. (2013). More than Revenue: Taxation as a Development Tool. Development in the Americas Report. Washington, DC and New York, United States: Inter-American Development Bank and Palgrave Macmillan.
Fellner, G., Sausgruber, R., & Traxler, C. (2013). Testing Enforcement Strategies in the Field: Threat, Moral Appeal and Social Information. Journal of the European Economic Association 11(3): 634–60.
Kleven, H.J. et al. (2011). Unwilling or Unable to Cheat? Evidence from a Tax Audit Experiment in Denmark. Econometrica 79(3): 651–92.
Sandmo, A. (2005). The Theory of Tax Evasion: A Retrospective View. National Tax Journal 58(4): 643–64.
Wenzel, M. (2002). “Altering Norm Perceptions to Increase Tax Compliance.” Working Paper 38. Canberra, Australia: Australian National University, Centre for Tax System Integrity.
Wenzel, M. (2007). The Multiplicity of Taxpayer Identities and Their Implications for Tax Ethics. Law and Policy 29(1): 31–50.
* Carlos Scartascini is a Principal Economist at the Research Department of the Inter-American Development Bank where he specializes in political economy and fiscal policy. For additional information, including publications, see www.cscartascini.org
1/ This note summarizes joint work with Lucio Castro (CIPPEC, Argentina). The opinions expressed in the note are those of the authors and do not necessarily reflect the views of the Inter-American Development Bank, its Board of Directors, or the countries they represent.
2/ For example, that is the case for personal income taxation and corporate income taxation in Argentina, the Dominican Republic, Ecuador and Guatemala, according to recent studies summarized in Corbacho, Fretes Cibils, and Lora (2013).
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