Behavioral experiments of alternative reporting regimes: transparency vs. burden By Laura Kalambokidis, Alex Turk, and Marsha Blumenthal Presented at the 2012 IRS Research Conference Washington, DC June 21, 2012

Summary Taxpayers may trade the opportunity to cheat for reduced compliance burden. – Trading depends on strength of desire to cheat relative to distaste for burden. If taxpayers who would have cheated make the trade, compliance could improve. Tax authority can tailor enforcement to regimes. An experiment can show how the propensity to cheat on taxes and the distaste for reporting burden influence regime choice.

Alternative regimes for reporting of income Automatic reporting  – Transparency of income to authority – High or perfect compliance – Lower compliance burden Self-reporting  – Income not transparent to authority – Opportunity to under-report income – Higher compliance burden

Laboratory experiment 330 subjects – 52 % female, 24% 30+ years of age, 38% minority, 28% not students, 64% employed 16 sessions, one hour each Subjects perform tasks to earn income, choose how much to report to authority, pay tax Random auditing, mis-reports corrected and under-reports charged penalty = penalty rate x tax due on under-reported income Within subject variation in experiment parameters

Experiment to explain regime choice Experimental Treatment Number of rounds Varying experimental parameters Results used to estimate 1: Observe compliance behavior 12Tax rate, audit rate, penalty rate Determinants of under- reporting, propensity to under-report (PTC) 2: Observe demand for burden reduction 5Burden reduction fee Willingness to pay for burden reduction (WTP) 3: Observe regime choice 9Audit rate in self- reporting regime, form type in automatic regime Determinants of regime choice, determinants of under-reporting conditional on choosing self-reporting

Treatment 1: Compliance behavior Propensity to cheat index – PTC1 = share of rounds (out of 12) subject under- reports income – PTC2 = share of income (over 12 rounds) subject failed to report Tobit model to explain amount of under- reported income: – decreases with audit and penalty rates – increases with actual income

Treatment 2: Demand for burden reduction Willingness to pay index (WTP) – Sum of fees over 5 rounds = $7.75 – WTP = sum of fees subject paid (over 5 rounds) / $7.75. – Mean =.16, WTP= 0 for 48% of subjects, WTP = 1 for 6% of subjects Aggregate demand for burden reduction… – …decreases with price – …more price-sensitive at higher prices

Treatment 3: Regime choice Automatic reporting regime Self-reporting regime 1. Learn parametersLevel of burden (none, short form, long form) Audit rate (0,.10,.50) 2. Choose regimeAutomaticSelf 3. Complete burden requirements Complete form, if anyComplete long form 4. Report incomeChoose amount to report 5. Face enforcementRandom audits, under- reports are penalized 6. Pay taxTax levied on actual earnings

Treatment 3: Regime choice Probit model to explain regime choice Higher audit rate  less likely to choose self- reporting Higher propensity to cheat  more likely to choose self-reporting Higher willingness to pay  less likely to choose self-reporting Higher income  more likely to choose self- reporting Level of burden in automatic regime not significant

Treatment 3: Under-reporting in self- reporting regime Linear regression and Tobit model to explain amount of under-reporting, conditional on choosing self-reporting regime. Higher audit rate  less under-reported income Higher propensity to cheat  more under- reported income Higher willingness to pay  more under- reported income

Further work Strengthen our responses to current research questions – Alternative measures of propensity to cheat, “gamerness” – Alternative measures of reporting burden – Tax authority’s problem: can regime choice improve compliance and/or reduce enforcement costs? Answer additional research questions – Responsiveness of work effort to tax rate – Correlate of cost of learning with understanding instructions and willingness to pay – Correlate personality type with compliance