First Things First: Using Anchoring Bias to Examine the Effect of Penalty Severity and Social Norms on Tax Compliance

Although ethics research shows that prospective penalties for tax fraud can increase taxpayers’ compliance with tax laws, we do not have a clear understanding of how perceptions of penalty severity impact tax compliance. To address this gap, I first conduct a survey to establish what propriety of penalty severity encourages compliance. I then examine experimentally whether taxpayers’ compliance is jointly influenced by penalty severity and social norms. I expect social norms to moderate the impact of penalty severity because social norms provide a contextual cue about the scope and relevance of an ethical issue. Specifically, I expect that when taxpayers anchor (do not anchor) on information about social norms, the positive impact of penalty severity on tax compliance is suppressed (not suppressed). My results are as predicted. I conclude that governments can increase compliance with tax laws by imposing appropriately severe tax fraud penalties and carefully considering the release of information related to compliance norms.