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Taxpayer Compliance Under Different Auditing Regimes

Taxpayer Compliance Under Different Auditing Regimes. Michael McKee Holly Professor of Economics, University of Tennessee Professor and Arthur Child Chair in Defence Economics, University of Calgary (as of January 2006). Introduction. Tax evasion magnitude – $200 Billion on the PIT Issues:

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Taxpayer Compliance Under Different Auditing Regimes

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  1. Taxpayer Compliance Under Different Auditing Regimes Michael McKee Holly Professor of Economics, University of Tennessee Professor and Arthur Child Chair in Defence Economics, University of Calgary (as of January 2006)

  2. Introduction • Tax evasion magnitude – $200 Billion on the PIT • Issues: • Government Revenues • Efficiency Losses • Social Norms • Tax Administration • Affects All Tax Sources (focus here on PIT)

  3. Introduction • Study of compliance • Illegal activity – observable? • Field vs. Lab data • Problems with field data • Observable actions • Low frequency of policy changes • Issues for experimental design • Parallelism

  4. Topic 1 – Tax Amnesties • Issues for tax amnesties • Revenue source – do amnesties generate revenues? • Post amnesty compliance – expectations of future amnesties)? • Future enforcement effort – effects? • Anticipation effect in absence of past amnesties in the present jurisdiction? • Reference: Alm, McKee, and Beck, 1990 NTJ

  5. Amnesty Experiments • Basic design – individuals receive income, disclose income voluntarily, pay tax on disclosed income, face random audit with penalty for taxes not paid • Experiment treatments: amnesty (y/n), post-amnesty enforcement effort, announcement of no future amnesty (y/n), announcement of possible amnesty (y/n) • Amnesty allows for payment of past due taxes without additional penalty

  6. Amnesty Experiments • Results • Amnesty without increased enforcement lowers future compliance • Anticipation effect lowers compliance • Enforcement effort increase after an amnesty increases future compliance • Revenue effects – amount collected increases when higher post-amnesty enforcement effort is announced

  7. Amnesty Experiments

  8. Amnesty Experiments

  9. Amnesty Experiments

  10. Topic 2 – Enforcement Effort • Economics of crime approach to evasion – increased enforcement effort leads to higher compliance • Issues • Effect of increased enforcement • Uncertainty in enforcement

  11. Enforcement Effort • Field “experiments” (Slemrod et al): • Minnesota “experiment” – approximately 2000 taxpayers in Minnesota get letter from Revenue Dept – letter states return subject to “close examination” • Analyze effect on compliance – but do not have post audit data and infer compliance from income reporting levels • Result: low- and middle-income taxpayers increased reported levels of income but high-income taxpayers reduced their reported income

  12. Enforcement Effort • Lab Experiments • Alm, Jackson and McKee (1992a and 1992b) test effects of increased enforcement • Alm, Jackson and McKee (1992a) test effects of enforcement uncertainty • Alm and McKee (2005) – test the Slemrod et al setting in lab where we know the actual compliance rate

  13. Enforcement Effort • Summary of lab results • AJM (1992b) report an increase of 10 percent in the audit rate will increase compliance by 2 percent but that the elasticity on the fine rate is extremely small (though significant) • AJM (1992a) report that uncertainty in the fine and audit rates significantly increases compliance • Alm and McKee (2005) report that being audited is the focal event rather than the penalty

  14. Enforcement Effort • Results from uncertainty experiments

  15. Topic 3 – Endogenous Enforcement • Use information provided in tax return to select for audit • Increase audit productivity through selection process • Unintended consequence is potential for coordination among taxpayers if the tax agency employs a rule based on comparing returns across individuals

  16. Endogenous Enforcement • Alm, Cronshaw and McKee (1993) compare performance of various endogenous enforcement strategies versus random audits • Results summarized: • Cutoff rule generates highest tax revenues but requires many audits so revenue/audit ratio is 1.86 • Conditional back audits have tax revenue/audit ratio of 6.77 • Random audits perform worst in terms of revenues but low probability settings yield highest revenue to audit ratio (8 for 5% audit probability)

  17. Endogenous Enforcement • Coordination game outcome? • Alm and McKee (2004) look at the use of endogenous selection via a DIF-type rule as used by the IRS • Results: • Cheap talk among taxpayers results in coordination outcome at low levels of compliance • Combining DIF with random audit can overcome the coordination effect

  18. Endogenous Enforcement

  19. Topic 4 – Indirect Effects • Effects of audits reach beyond the taxpayers actually audited – what is the causal effect? • Field data (Dubin, Graetz and Wilde, 1990) report a ripple effect of 6 • Experiments (Alm, Jackson and McKee, 2005) yield a ripple effect of about 4 • Question: how does this effect arise? • Question: can policy makers increase the effect?

  20. Indirect Effects • Experiment Setting and Features • Parallelism Emphasis • Tax Language: screen refers to tax form, tax rate, audit and so on • Earn income • Individual audits • Treatments are: Communication and Official Announcements

  21. Indirect Effects – Experiment Details • Instructions, practice rounds and questions • Earn income – figure 1 • Pay taxes (Disclose Income) – figure 2 • Timed stage – failure to file results in 10% penalty plus automatic audit • Undergo individual audit • Bingo cage on screen – after the filing decision • Receive feedback information re own and others’ audit • Round ends • Treatments: Information – Official vs. Unofficial • What we don’t include here: • Public goods – tax receipts in “black hole” • Systematic (endogenous) audits • Varying tax rates or penalty rates

  22. Income Earning Image

  23. Tax Form Image

  24. Indirect Effects

  25. Indirect Effects • Official provision of previous audit information by the tax authority has negative effect on subsequent compliance • Provision of unofficial information (allowed communication) by taxpayers themselves increases compliance • Communication that reports evasion leads to lower compliance while communication that reports compliance leads to higher compliance – norms • Communication that reports not being audited has negative effect on compliance while communication that reports being audited has a positive effect – effective enforcement

  26. Indirect Effects

  27. Conclusions • What have we learned? • Deterrence can work • Amnesties are useful if accompanied by enforcement increases • Endogenous audit selection is generally useful but must be accompanied by a random audit • Audit information affects compliance • What can we learn? • Third party reporting • Portfolio evasion • Taxpayer-taxpayer communication

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