Working Paper: NBER ID: w15769
Authors: Henrik J. Kleven; Martin B. Knudsen; Claus T. Kreiner; Søren Pedersen; Emmanuel Saez
Abstract: This paper analyzes a randomized tax enforcement experiment in Denmark. In the base year, a stratified and representative sample of over 40,000 individual income tax filers was selected for the experiment. Half of the tax filers were randomly selected to be thoroughly audited, while the rest were deliberately not audited. The following year, "threat-of-audit" letters were randomly assigned and sent to tax filers in both groups. Using comprehensive administrative tax data, we present four main findings. First, we find that the tax evasion rate is very small (0.3%) for income subject to third-party reporting, but substantial (37%) for self-reported income. Since 95% of all income is third-party reported, the overall evasion rate is very modest. Second, using bunching evidence around large and salient kink points of the nonlinear income tax schedule, we find that marginal tax rates have a positive impact on tax evasion, but that this effect is small in comparison to avoidance responses. Third, we find that prior audits substantially increase self-reported income, implying that individuals update their beliefs about detection probability based on experiencing an audit. Fourth, threat-of-audit letters also have a significant effect on self-reported income, and the size of this effect depends positively on the audit probability expressed in the letter. All these empirical results can be explained by extending the standard model of (rational) tax evasion to allow for the key distinction between self-reported and third-party reported incomes.
Keywords: tax evasion; audit experiment; third-party reporting; Denmark
JEL Codes: H3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Marginal tax rates (H29) | Tax evasion (H26) |
| Third-party reporting (Y50) | Tax evasion (H26) |
| Audits (M42) | Self-reported income (D31) |
| Threat-of-audit letters (H26) | Self-reported income adjustments (H31) |
| Probability of audit (M42) | Self-reported income adjustments (H31) |