Dynamic effects of tax audits and the role of intentions

Abstract

Using a random audit program covering more than 17,000 tax returns, I study how tax audits affect the subsequent compliance behavior of self-employed with varying intentions to comply. Leveraging novel information provided by auditors on taxpayers’ perceived willingness to comply, I find that unintentional non-compliers, driven by inattention or misunderstandings of the tax rules, exhibit higher compliance in subsequent years. This results in a revenue increase equivalent to 340% of the tax uncovered from the audit after 5 years. In contrast, intentional non-compliers who deliberately evade taxes and are typically targeted for operational audits do not respond to audits and have a low recovery rate for evaded taxes. Based on these findings, I illustrate how risk scores derived from pre-audit information can be used to target taxpayers expected to respond strongly to audits, leading to increased revenue gains of 87% compared to an approach that focuses on initial revenue from audits. Finally, I propose targeted and personalized guidance as a cheaper alternative to mitigate unintentional misreporting compared to expensive audits.