Friday, July 29, 2011
While Americans may complain about paying taxes, a new working paper from the National Bureau of Economic Research found that the vast majority are honest on their tax returns.
Economists Sara LaLumia of Williams College and James M. Sallee of the University of Chicago investigated whether people decide whether or not to commit tax evasion if broad benefits outweighs a tiny risk of being caught and punished.
LaLumia and Sallee compared data from before and after a 1987 change in the way tax laws required Americans to report their dependent children. The new law required more verification that the children existed — resulted in millions of previously claimed children going “missing.”
Prior to 1987, all a filer needed to do was list each dependent’s first name. In 1987 they were required to list a Social Security number as well.
“[M]any filers had been cheating before the reform,” the report stated. “Yet, the number of filers who availed themselves of this evasion opportunity is dwarfed by the number of filers who passed up substantial tax savings by not claiming extra dependents. By declining the opportunity to cheat, these taxpayers reveal information about their willingness to pay to be honest.”
According to the data published by the NBER, while it was relatively easy and low-risk to cheat, 97.5% of taxpayers resisted the temptation to lie about how many dependents live in their households.
How much are people willing to forego to be honest, to follow the rules? When people do break the rules, what can standard data sources tell us about their behavior? Standard economic models of crime typically assume that individuals are indifferent to dishonesty, so that they will cheat or lie as long as the expected pecuniary benefits exceed the expected costs of being caught and punished. We investigate this presumption by studying the response to a change in tax reporting rules that made it much more difficult for taxpayers to evade taxes by inappropriately claiming additional dependents. The policy reform induced a substantial reduction in the number of dependents claimed, which indicates that many filers had been cheating before the reform. Yet, the number of filers who availed themselves of this evasion opportunity is dwarfed by the number of filers who passed up substantial tax savings by not claiming extra dependents. By declining the opportunity to cheat, these taxpayers reveal information about their willingness to pay to be honest. We present a novel method for inferring the characteristics of taxpayers in the absence of audit data. Our analysis suggests both that this willingness to pay to be honest is large on average and that it varies significantly across the population of taxpayers.
(Hat Tip: Sam Young.)