ABSTRACT
Over the past several decades, there has been a growing interest in theoretical, empirical, and experimental work on all aspects of tax compliance and tax evasion. A common theme in much of this work is that the traditional economics-of-crime approach to compliance, while containing many insights, is simply inadequate as a framework for more fully understanding why people pay taxes. Rather, the basic model of individual choice must be expanded by introducing some aspects of behavior or motivation considered explicitly by other social sciences. Many of these aspects can be discussed under the general rubric of behavioral economics, broadly defined as an approach that uses methods and evidence from other social sciences (especially psychology) to inform the analysis of individual and group decision-making. The original chapters in this volume represent an attempt to provide exactly this new framework on compliance – one that moves beyond the economics-of-crime perspective, one that provides a more complete understanding of individual (and group) decisions, and one that is more consistent with empirical evidence. The chapters in this volume summarize the existing state of knowledge of tax compliance and tax evasion, present new thinking about this issue, and analyze the empirical relevance of these new perspectives. They were presented at a conference entitled “Tax Compliance and Tax Evasion”, held in Atlanta in October 2007 and sponsored by the International Studies Program of the Andrew Young School of Policy Studies at Georgia State University. It is useful at the start to identify more fully the basic insight – and the basic problem – with the standard economic approach to compliance. To date, the basic theoretical model used in nearly all research on tax compliance begins with the economics-of-crime model of Becker (1968), first applied to tax compliance by Allingham and Sandmo (1972).1 Here, a rational individual is viewed as maximizing the expected utility of the tax evasion gamble, weighing the benefits of successful cheating against the risky prospect of detection and punishment, and individuals pay taxes because they are afraid of getting caught and penalized if they do not report all income. This approach gives the plausible and productive result that compliance depends upon audit rates and fine rates. Indeed, the central point of this approach is that an individual pays taxes because – and only because – of this fear of detection and punishment. The obvious policy implication here
is that enforcement matters because enforcement can affect the financial considerations that motivate – at least in part – an individual’s compliance choices. However, it is essential to recognize that this approach also concludes that an individual pays taxes because – and only because – of the economic consequences of detection and punishment. Again, this is a plausible and productive insight, with the obvious implication that the government can encourage greater tax compliance by increasing the audit and the penalty rates. The many extensions of this economics-of-crime approach considerably complicate the theoretical analyses, and generally render clear-cut analytical results impossible. Nevertheless, these extensions retain the basic approach and the basic result: individuals focus exclusively on the financial incentives of the evasion gamble, and individuals pay taxes solely because they fear detection and punishment. However, it is clear to many observers that compliance cannot be explained entirely by such purely financial considerations, especially those generated by the level of enforcement. The percentage of individual income tax returns that are subject to a thorough tax audit is generally quite small in most countries – almost always considerably less than 1 percent of all returns. Similarly, the penalty on even fraudulent evasion seldom exceeds more than the amount of unpaid taxes, and these penalties are infrequently imposed; civil penalties on non-fraudulent evasion are even smaller. Taxpayer audits are a central feature of the voluntary compliance system in all countries, largely because more frequent audits are thought to reduce tax evasion. Even so, a purely economic analysis of the evasion gamble suggests that most rational individuals should either underreport income not subject to source withholding or overclaim deductions not subject to independent verification because it is extremely unlikely that such cheating will be caught and penalized. However, even in the least compliant countries evasion never rises to levels predicted by a purely economic analysis, and in fact there are often substantial numbers of individuals who apparently pay all (or most) of their taxes all (or most) of the time, regardless of the financial incentives they face from the enforcement regime. The basic model of individual compliance behavior therefore implies that rational individuals (especially those whose incomes are not subject to thirdparty sources of information) should report virtually no income. Although compliance varies significantly across countries and across taxes, and is often quite low, compliance seldom falls to a level predicted by the standard economic theory of compliance. It seems implausible that government enforcement activities alone can account for these levels of compliance; the basic model is certainly unable to explain this behavior. Indeed, the puzzle of tax compliance behavior may well be why people pay taxes, not why they evade them (Slemrod, 1992; Torgler, 2007). This observation suggests that the compliance decision must be affected in ways not fully captured by the basic economics-of-crime approach. What other factors may explain why people pay taxes? It is this fundamental question that motivates the chapters in this volume, and it is the insights of behavioral economics that provide many of the bases for these chapters.
