Unwilling or Unable to Cheat? Evidence from a Randomized Tax Audit Experiment in Denmark

This paper analyzes a randomized tax enforcement experiment in Denmark. In the base year, a stratified and representative sample of over 40,000 individual income tax filers was selected for the experiment. Half of the tax filers were randomly selected to be thoroughly audited, while the rest were deliberately not audited. The following year, "threat-of-audit" letters were randomly assigned and sent to tax filers in both groups. Using comprehensive administrative tax data, we present four main findings. First, we find that the tax evasion rate is very small (0.3%) for income subject to third-party reporting, but substantial (37%) for self-reported income. Since 95% of all income is third-party reported, the overall evasion rate is very modest. Second, using bunching evidence around large and salient kink points of the nonlinear income tax schedule, we find that marginal tax rates have a positive impact on tax evasion, but that this effect is small in comparison to avoidance responses. Third, we find that prior audits substantially increase self-reported income, implying that individuals update their beliefs about detection probability based on experiencing an audit. Fourth, threat-of-audit letters also have a significant effect on self-reported income, and the size of this effect depends positively on the audit probability expressed in the letter. All these empirical results can be explained by extending the standard model of (rational) tax evasion to allow for the key distinction between self-reported and third-party reported incomes.

[1]  Raj Chetty.  Is the Taxable Income Elasticity Sufficient to Calculate Deadweight Loss? The Implications of Evasion and Avoidance , 2008 .

[2]  Emmanuel Saez,et al.  Why Can Modern Governments Tax so Much? An Agency Model of Firms as Fiscal Intermediaries , 2009 .

[3]  J. Sallee,et al.  The value of honesty: empirical estimates from the case of the missing children , 2011 .

[4]  Shlomo Yitzhaki,et al.  On the Excess Burden of Tax Evasion , 1987 .

[5]  Alexander W. Cappelen,et al.  Fair Tax Evasion , 2013 .

[6]  Charles T. Clotfelter,et al.  Tax Evasion and Tax Rates: An Analysis of Individual Returns , 1983 .

[7]  Jonathan S. Feinstein,et al.  An Econometric Analysis of Income Tax Evasion and its Detection , 1991 .

[8]  J. Slemrod,et al.  Putting Firms into Optimal Tax Theory , 2006 .

[9]  W. Becker,et al.  The impact of public transfer expenditures on tax evasion: An experimental approach , 1987 .

[10]  Jeffrey A. Dubin,et al.  AN EMPIRICAL ANALYSIS OF FEDERAL INCOME TAX AUDITING AND COMPLIANCE , 1988, National Tax Journal.

[11]  Joel Slemrod,et al.  Do Normative Appeals Affect Tax Compliance? Evidence from a Controlled Experiment in Minnesota , 2001, National Tax Journal.

[12]  Shlomo Yitzhaki,et al.  Income tax evasion: A theoretical analysis , 1974 .

[13]  Rupert Sausgruber,et al.  University of Innsbruck Working Papers in Economics and Statistics Testing Enforcement Strategies in the Field : Legal Threat , Moral Appeal and Social Information , 2009 .

[14]  Joel Slemrod,et al.  Taxpayer response to an increased probability of audit: evidence from a controlled experiment in Minnesota , 2001 .

[15]  J. Slemrod,et al.  Estimating Tax Noncompliance With Evidence from Unaudited Tax Returns , 2007 .

[16]  L. Franzoni.  Tax Compliance , 2008 .

[17]  Agnar Sandmo,et al.  Income tax evasion: a theoretical analysis , 1972 .

[18]  J. Andreoni,et al.  Do Police Reduce Crime ? Estimates Using the Allocation of Police Forces After a Terrorist Attack , 2003 .

[19]  H. Kleven,et al.  Estimating Taxable Income Responses using Danish Tax Reforms , 2014 .

[20]  Gary H. McClelland,et al.  Why do people pay taxes , 1992 .

[21]  J. Alm,et al.  Getting the word out: Enforcement information dissemination and compliance behavior , 2009 .

[22]  Shlomo Maital,et al.  A simulation study of income tax evasion , 1978 .

[23]  D. Nagin,et al.  The Anatomy of Tax Evasion , 1989 .

[24]  J. Slemrod.  Income Creation or Income Shifting? Behavioral Responses to the Tax Reform Act of 1986 , 1995 .

[25]  J. Slemrod.  A General Model of the Behavioral Response to Taxation , 1998 .

[26]  Paul E. Carrillo,et al.  Taxes, Prisons, and CFOs: The Effects of Increased Punishment on Corporate Tax Compliance in Ecuador , 2011 .

[27]  J. Alm.  Measuring, explaining, and controlling tax evasion: lessons from theory, experiments, and field studies , 2012 .

[28]  Raj Chetty,et al.  Adjustment Costs, Firm Responses, and Labor Supply Elasticities: Evidence from Danish Tax Records , 2010 .

[29]  Agnar Sandmo,et al.  The Theory of Tax Evasion: A Retrospective View , 2005, National Tax Journal.

[30]  Michael McKee,et al.  ESTIMATING THE DETERMINANTS OF TAXPAYER COMPLIANCE WITH EXPERIMENTAL DATA , 1992, National Tax Journal.

[31]  J. Slemrod.  Cheating ourselves: The economics of tax evasion , 2007 .

[32]  Kim M. Bloomquist.  Tax Evasion, Income Inequality and Opportunity Costs of Compliance , 2003 .

[33]  J. Slemrod,et al.  Administration and compliance , 2010 .

[34]  J. Slemrod.  Why people pay taxes : tax compliance and enforcement , 1992 .

[35]  Emmanuel Saez,et al.  Do Taxpayers Bunch at Kink Points? , 1999 .

[36]  P. J. Beck,et al.  Experimental Evidence on Taxpayer Reporting under Uncertainty , 1991 .

[37]  B. Frey,et al.  The effects of tax administration on tax morale , 1992 .

[38]  Lars P. Feld,et al.  Tax Compliance as the Result of a Psychological Tax Contract: The Role of Incentives and Responsive Regulation , 2006 .

[39]  Jeffrey A. Dubin,et al.  THE EFFECT OF AUDIT RATES ON THE FEDERAL INDIVIDUAL INCOME TAX, 1977-1986 , 1990, National Tax Journal.