Deterrence and Beyond: Suggestions to Improve Voluntary Tax Compliance

I. Introduction

The IRS has been dealt harsh budget cuts over the past decade. Even as the agency’s responsibilities increased,¹ federal appropriations fell by 20 percent in inflation-adjusted dollars between 2010 and 2018. These budget cuts resulted in a 22 percent decrease in the agency’s overall workforce and a 30 percent reduction in employees focused on enforcement activities. During this period, the number of highly specialized employees focused on the most complex enforcement tasks was cut by a staggering 48 percent. Thus, examination rates for both individual and corporate taxpayers fell by 40 percent between 2010 and 2018.²

In May 2021 the Biden administration released a plan to enhance tax enforcement activities.³ The framework depended on a significant increase in the IRS’s budget. The administration projected that for each additional dollar allocated to enforcement, tax revenue would increase by four dollars. A budget increase would fund (1) enhanced information reporting for businesses, (2) enhanced information reporting for cryptoasset exchanges and custodians, (3) increased oversight of paid tax return preparers, and (4) increased electronic filing of tax returns. The administration argued that the changes would allow for a more targeted enforcement program. Because of a lack of support from Republicans, additional IRS funding was dropped from the infrastructure bill. It isn’t yet known whether, and to what extent, the IRS’s budget will increase for fiscal 2022. However, it is unlikely that the Biden administration will be able to fund its ambitious wish list as outlined in the green book.⁴

Even with an increased budget, the IRS would be limited to auditing only a small percentage of taxpayers. An enhanced budget might allow the agency to better target high-income taxpayers, but the overall audit rate would remain rather low. This report summarizes the academic literature focused on tax evasion deterrence measures. Academic studies provide insight regarding how best to allocate existing IRS funding as well as potential increases to the agency’s budget. This report also discusses research focused on other determinants of tax compliance. Significant efforts have been made to understand factors beyond deterrence mechanisms that might nudge taxpayers into voluntary compliance. The results of these studies suggest ways the IRS might improve compliance even in the absence of additional funding that would increase the audit rate.

It is important to note that academic research acknowledges that there are issues with available tax evasion data as well as limitations related to research methods used to study compliance.⁵ Researchers are increasingly working directly with tax authorities to conduct field studies to alleviate some of these concerns. Despite these limitations, research efforts centered around tax compliance provide valuable insight that can inform policy decisions. This area of research is growing as studies examine taxpayers and tax authorities across several countries.⁶ While studies conducted outside the United States might shed light on the compliance behavior of U.S. taxpayers, it is unclear the extent to which these studies generalize to a U.S. population. Therefore, this report evaluates studies focused on the U.S. tax system and the IRS and, unless stated otherwise, papers that use samples of U.S. taxpayers.

II. Tax Evasion Deterrence

The first risk-return model to explain tax compliance was rooted in deterrence theory.⁷ The model assumes that taxpayers are utility maximizers, determining optimal levels of tax compliance by considering tax penalties and detection risk. This framework does not consider the possibility that taxpayers might be willing to comply with their tax obligations because of psychological or social influences. The risk-return assumption motivated much research examining the relationship between enforcement efforts and tax compliance. This intuitive hypothesis that self-interest is an important factor as taxpayers decide whether to evade is supported by numerous academic studies.

The risk-return model relies on two variables to explain observed levels of tax compliance: detection risk and sanctions if evasion is discovered. A 2007 meta-analysis⁸ examines the results of 20 experimental studies of tax evasion and confirms the predictions derived from models grounded in deterrence theory: “The literature unambiguously shows that raising either the fine rate or the probability of audit will increase tax compliance.” A more recent review of the literature published in 2019⁹ argues that a comprehensive assessment of tax compliance studies demonstrates that audit risk has a greater deterrence effect than tax penalties.

A. Audit Risk

The results of early academic studies using lab experiments converge on the finding that increased audit risk improves tax compliance.¹⁰ While this work provides insight regarding the effectiveness of audits, these studies lack external validity. A more recent field study conducted in collaboration with the Minnesota Department of Revenue suggests that increasing the salience of audit risk does not have a uniform effect across all individual taxpayers.¹¹ Low- and middle-income taxpayers who received a letter stating that their Minnesota income tax return would be “closely examined” reported more income compared with a control group that did not receive a letter. This effect was stronger for taxpayers with more opportunity to evade, taxpayers with income that was not subject to third-party information reporting.

However, high-income taxpayers with this type of income (self-employment or farm income) reported less income after receiving the same letter when compared with a control group. The authors of this study speculate that more sophisticated taxpayers or their tax professionals view an audit as a negotiation and use the originally filed tax return as a starting point for eventual compromise. This study suggests that different enforcement efforts may be necessary to increase compliance among high-income taxpayers.

A 2018 study examines the effect of previous audit experience on future compliance behavior by using data from the IRS National Research Program (NRP).¹² Results reveal that, on average, taxpayers selected for audit under this program increase reported taxable income by 2.9 percent when compared with a control group of unaudited taxpayers. This effect persists, on average, for at least six years. This finding is consistent with the argument that taxpayers with recent audit experience perceive higher audit risk and, therefore, evade less.¹³

The effect of an NRP audit isn’t constant across all types of taxable income. While reported wage income increases by 1.36 percent over the three years after an audit, there is a significantly larger effect for taxpayers with opportunity to evade. Taxpayers increase reported self-employment income by 13.14 percent over the same period. Notably, reported self-employment income spikes for two years following an audit, but this effect diminishes in year 3. Taxpayers report less self-employment income in years 5 and 6 following an NRP audit, suggesting that this group becomes more noncompliant over time. Finally, the deterring effect of a previous audit is most pronounced among taxpayers in the lowest quintile of taxable income. Taxpayers in the top quintile report less taxable income in the year after an audit.

A second study observes self-employed taxpayers selected for audit under a strategic approach rather than random selection.¹⁴ Overall, audited taxpayers report 12 percent more income in the year following the audit relative to a control group of taxpayers who didn’t experience an audit. However, subsequent reporting behavior depends on the outcome of the audit. Taxpayers who experienced audit adjustments increasing their tax liability reported 64 percent more income in the following year. For this group, the deterring effect of a previous audit is persistent, as taxpayers report 44 percent more taxable income three years after the audit. However, taxpayers that were not assessed additional tax upon conclusion of the audit reported 15 percent less taxable income in the year following the audit and 21 percent less income three years following the audit.

While academic literature provides support demonstrating the deterring effect of audit risk, there is also evidence of a backfiring effect if a tax authority conducts too many audits.¹⁵ An examination of OECD countries finds a U-shaped relationship between audit rates and noncompliance. As audit rates increase, compliance improves, but only to a point. If audit rates creep too high, compliance suffers. The authors suggest that tax authorities should demonstrate some level of trust that taxpayers will voluntarily comply, in an effort to maintain high levels of tax compliance.

B. Tax Penalties

In addition to audit threat, the risk-return model relies on sanctions — penalties assessed when tax evasion is detected — to explain tax compliance behavior. For sanctions to be effective, they must meet three criteria. First, sanctions must be clearly communicated. Second, the penalties must be harsh enough to deter tax evasion. And third, taxpayers must perceive that deterrence efforts will be enforced.¹⁶ Studies converge on the finding that penalties are a more effective deterrent against tax evasion when penalty information is clearly communicated.¹⁷ It is difficult to conclude how harsh the sanctions must be for them to be effective. Much of the work examining the magnitude of penalties has been conducted in an artificial lab setting in which penalty rates can be manipulated. The results of these studies might not generalize to a more realistic tax environment. While field studies examining compliance are becoming more common, tax authorities are unable or unwilling to experimentally adjust the penalty rate across various groups of taxpayers to determine optimal magnitude.

Overall, the compliance literature suggests that economic sanctions increase compliance when the perceived probability of detection is sufficiently high. This suggests that, independently, penalties aren’t an effective deterrent against tax evasion.¹⁸ While there have been exceptions,¹⁹ early studies converge on the observation that sanctions may be ineffective if detection risk is too low.²⁰ Lab experiments examining the effect of tax penalties have been criticized for imposing sanctions at a rate much higher than actual taxpayers face in the real world. This limitation was addressed in an experimental study that imposed realistic penalties for noncompliance.²¹ Results from the study suggest that when perceived detection is low, tax compliance suffers, even when penalties are assessed at the maximum level. However, when perceived detection is high, compliance improves even when penalties are assessed at their lowest level. The authors conclude that detection risk has the greater influence on compliance.

Recently, academics have worked directly with tax authorities to conduct field experiments in real-world settings. These studies focus on the salience of tax penalties. In a 2018 study,²² researchers collaborated with the city of Detroit to encourage suspected nonfilers to submit an income tax return. Reminder letters were sent to taxpayers. Letters included one of the following treatments: (1) increased penalty salience, (2) increased punishment probability, (3) reduced compliance cost (the necessary tax form was included with the reminder letter, making it easier for nonfilers to submit a return), (4) increased focus on civic pride, or (5) increased penalty salience and increased punishment probability. The increased penalty salience condition informed taxpayers of various failure-to-file penalties. The increased punishment probability treatment did not provide audit rates; rather, the letter included the taxpayer’s known federal taxable income. The expectation was that recipients would perceive greater detection risk knowing that the city had information regarding their annual income.

When compared with a control group that received a simple reminder letter that provided only the website to access the necessary tax form and instructions regarding where to file and how to remit one’s tax payment (response rate was 3.8 percent), the penalty salience condition resulted in the highest taxpayer response rate (10.1 percent). The combined penalty and punishment probability condition was nearly as successful (9.7 percent). The punishment probability treatment resulted in a response rate half that of the other two treatments (4.9 percent). This study suggests that simply reminding taxpayers of potential penalties and interest for late filing and payment will improve compliance.

Two similar studies were conducted in collaboration with the Colorado DOR²³ and the city of Philadelphia.²⁴ The focus of these studies was to encourage payment from taxpayers with known outstanding liabilities rather than to encourage nonfilers to submit a return. In the Colorado study, letters requesting prompt payment were sent to delinquent taxpayers. The letters included one of the following treatments: (1) a detailed explanation of interest rates and failure-to-pay penalties, (2) a general explanation that interest and penalties are assessed on late payments, or (3) a social norm explaining that most Colorado taxpayers pay their tax bill on time. The effect of each treatment condition is compared with a control group that received a standard letter explaining that taxpayers can avoid an interest assessment if their account is paid within 30 days. Results demonstrate that letters highlighting and providing information about financial penalties modestly increased the payment rate among the sample of delinquent taxpayers. Notices that provided more detail regarding potential penalties were more successful than notices that provided general information.²⁵

Additional analyses reveal that while the detailed penalty notice induced prompt and full payment by taxpayers in the low and middle tertiles of balances due, the notice had no effect on taxpayers with the highest outstanding tax liabilities. However, the detailed notice did increase the number of taxpayers with large balances that enrolled in a payment plan. Also, the general penalty notice had a positive effect on prompt payment, but the increase was only half that of taxpayers receiving the detailed notice. The magnitude of the effect of receiving a detailed penalty notice is small (just a 4.1 percent increase in prompt payment when compared with the control group), but there is almost no cost associated with including the detailed penalty messaging in the payment request letter. Moreover, this increase in taxpayers making prompt payment reduces the need for more costly follow-up enforcement activities.

The Philadelphia study²⁶ researchers developed several treatment conditions to encourage prompt payment of delinquent property taxes. This study included two treatment conditions that emphasized potential economic sanctions. The first notice informed taxpayers that nonpayment would lead to fines and potentially a lien on their property. The letter then listed properties near the taxpayer’s property that had been subject to a lien. The second notice informed taxpayers that nonpayment could lead to a sheriff’s sale of the property to pay the overdue tax bill. This letter provided the number of properties, listing three specifically, in the taxpayer’s neighborhood that had been sold at a sheriff’s sale.

Other treatment conditions included messaging emphasizing: (1) exchange equity, (2) social norms, and (3) civic duty. Response rates to each treatment were compared with a holdout sample that received no reminder letter. The most effective treatment conditions were letters that increased the salience of penalties. However, the effect of these notices was not persistent. There was no evidence that taxpayers who received a notice in 2015 improved their compliance in 2016. Like the Colorado study, revenue gains were modest. But overall, these studies offer a low-cost solution for improving prompt payment of one’s tax liability.

C. Information Reporting

The Biden administration has identified enhanced information reporting as one avenue for improving tax compliance. Third-party reporting dramatically increases detection risk, and IRS data demonstrates that this strategy reduces evasion. The IRS’s most recent analysis estimates a 7 percent noncompliance rate for income subject to substantial information reporting. Compare this with a 17 percent noncompliance rate for income subject to some information reporting and a 55 percent noncompliance rate for income subject to little or no third-party reporting.²⁷ While this data supports the effectiveness of information reporting in mitigating tax evasion, research provides evidence that taxpayers may offset an increase in reported income with additional expenses, muting the efficacy of third-party reporting requirements.²⁸

Researchers examine the effect of information reporting mandated with the introduction of Form 1099-K. This expanded third-party reporting obligation resulted in a significant increase in taxpayers reporting business income for the first time. Also, reported gross receipts increased by up to 24 percent. However, results of this study reveal a 13 percent increase in reported expenses, especially in the “other expense” category that is difficult to verify. Enhanced information reporting appears to result in more accurate reporting of gross receipts, but this positive effect on compliance is mitigated by taxpayers increasing deductions for expenses that are not subject to information reporting requirements.

When considering an expansion of third-party reporting requirements, research suggests that policymakers should anticipate a possible backfiring effect. This effect has been observed when examining audit rates.²⁹ Compliance suffers when audit rates creep too high. It is reasonable to expect that taxpayers may consider other avenues to evade taxes if they feel the IRS is too heavy-handed in its surveillance of taxpayer transactions. Increased deterrence measures should be balanced with efforts that encourage cooperation between taxpayers and the IRS.

D. Deterrence Conclusion

As a whole, academic research finds that self-interest is an important factor in the tax compliance decision. While detection risk, rather than tax penalties, appears to drive improved compliance, the literature demonstrates that low-cost strategies that simply make penalties more salient can increase tax revenue. Studies find that high-income taxpayers respond to audit risk and audit experience differently from other taxpayers; current deterrence measures aren’t as effective for this group. Researchers suggest that high-income taxpayers and their tax advisers may view an audit as a negotiation and prepare tax returns as a starting point for an eventual compromise. Policymakers and the IRS should consider adjusting enforcement strategies to change this perception. Research also suggests that current enforcement efforts may not be persistent. A program involving repeated messaging might be necessary to increase the effectiveness of existing deterrence efforts. Finally, to avoid a potential backfiring effect, a tax authority should balance enhanced deterrence measures with strategies that improve cooperation with taxpayers to promote voluntary compliance.

III. Beyond Deterrence

The tax compliance literature finds that factors other than deterrence and taxpayer self-interest influence the compliance decision. Observed levels of tax compliance are much higher than the predictions derived from risk-return models grounded in deterrence theory.³⁰ This observation has motivated much research focused on the psychological and social influences on taxpayers as they fulfill their tax obligations. This research provides ideas for promoting voluntary compliance without increasing the audit rate or assessing additional tax penalties. Understanding how to improve compliance without relying on detection risk is important for several reasons. First, while enforcement efforts are successful in recovering a fraction of lost tax revenue, a large portion of the tax gap remains uncollected.³¹ Today it is unknown whether or to what extent Congress will increase the IRS’s budget to fund an enhanced deterrence program. Also, it is costlier to implement aggressive enforcement measures than to encourage taxpayers to willingly cooperate with the tax authority.³² Finally, enforcement efforts that are perceived to be unreasonable can backfire, resulting in more tax evasion in the long term.³³

To improve voluntary tax compliance, one must understand the psychological and social factors that promote compliance under the condition of low audit risk. While studies conducted outside the United States have demonstrated the effectiveness of moral appeals and highlighting social norms,³⁴ similar results have not been observed when using a U.S. sample.³⁵ Recent field work described in the previous section (the reminder letter studies)³⁶ demonstrates that while letters emphasizing tax penalties are effective, letters communicating a social norm or reminding taxpayers of their civic duty do not result in improved compliance. It appears that U.S. taxpayers are more concerned about fairness. Academic studies using samples of U.S. taxpayers support a positive relationship between fairness perceptions and compliance behavior.³⁷

A. Equity Concerns

The tax compliance process can be complex. The IRS estimates that taxpayers spend, on average, 12 hours preparing their annual income tax return.³⁸ Even taxpayers that outsource the preparation of their return must spend time on record keeping and information gathering activities. After filing their returns, millions of taxpayers receive notices from the IRS requiring them to address errors or inconsistencies.³⁹ Taxpayers encounter various justice-related issues throughout the tax preparation process. The fairness perceptions they develop as they fulfill their tax obligations may affect their decision-making. Studies consistently demonstrate a positive relationship between voluntary compliance and fairness. Taxpayers are more compliant when they perceive the tax system as equitable.

This idea that taxpayers are more compliant when they feel they are treated fairly is more complicated than it might sound because there are various types of equity to consider. Within the tax compliance literature, most fairness studies rely heavily on equity theory,⁴⁰ which is grounded in distributive justice, to explain the relationship between fairness and compliance.⁴¹ Distributive justice focuses on the fairness of the tax outcome and suggests that taxpayers consider horizontal, vertical, and exchange equity when considering whether the tax system is fair. While distributive justice was the focus of most early studies, the evolution of the justice literature suggests that fairness perceptions don’t only depend on concerns about one’s tax liability.⁴²

Taxpayers evaluate the fairness of the tax collection process independently from judgments concerning their tax liability.⁴³ Also, the justice literature suggests that individuals consider how the tax authority treats taxpayers as they decide whether a tax system is fair. These concerns are distinct from perceptions regarding the fairness of the procedures used by that authority.⁴⁴ Finally, studies argue that fairness judgments regarding the quality of explanation received from a tax authority are distinct from both the treatment received by the authority and perceptions regarding the fairness of the collection process.⁴⁵ Overall, the justice literature identifies four distinct underlying equity dimensions: distributive, procedural, interpersonal, and informational justice.⁴⁶

B. Distributive Justice

Distributive justice emphasizes the importance of exchange outcomes when forming fairness judgments. Equity theory is often used to describe the process by which taxpayers develop fairness perceptions regarding their tax liability. The theory suggests that taxpayers conduct a cognitive evaluation, comparing their tax burden with both tax payments made by other taxpayers and the benefits they receive in exchange for their tax dollars, when forming fairness judgments.⁴⁷ Equity theory predicts that when taxpayers conclude that their relationship with the tax authority is unfair, they manipulate their voluntary compliance to improve the fairness of the exchange. Taxpayers may consider evasion if they perceive they are being treated unfairly and that their tax liability is too high.

Individuals consider both the distribution of tax burdens and the distribution of tax-funded benefits as they evaluate the distributive justice of a tax system.⁴⁸ As taxpayers evaluate the distribution of tax burdens, they focus on the horizontal and vertical equity of the tax system. Exchange equity becomes important as taxpayers consider the distribution of benefits. Therefore, the tax compliance literature views distributive justice as multidimensional with three underlying factors: horizontal, vertical, and exchange equity.⁴⁹

Horizontal equity requires that taxpayers with comparable income bear similar tax burdens.⁵⁰ Studies have examined the importance of horizontal equity by using lab experiments during which research participants earn experimental income and make reporting decisions to an experimental tax authority. Results reveal that individuals are more compliant when they believe they are paying an average rate of tax,⁵¹ while compliance suffers when participants are told their tax rate is higher than average.⁵² Overall, research supports the importance of horizontal equity as taxpayers make voluntary compliance decisions.

Vertical equity has two main elements, the progressivity of tax rates and after-tax income equality.⁵³ As taxpayers consider vertical equity, they are making judgments regarding the fairness of a system under which tax rates increase with income. Also, they consider the fairness of a system that redistributes income from high-income taxpayers to low-income taxpayers through tax credits. Studies converge on the finding that U.S. taxpayers prefer progressive tax rates.⁵⁴ Moreover, in an experimental setting, greater compliance is observed under a progressive system when compared with a proportionate rate structure.⁵⁵ Researchers speculate that violations of vertical equity may be used to justify noncompliance.⁵⁶ Collectively, these studies suggest that taxpayers not only prefer progressive rates but also adjust voluntary compliance to restore vertical equity when they perceive it is lacking.

Taxpayers evaluate exchange equity as they compare their tax burden with the benefits they receive from the government.⁵⁷ Research evaluating the importance of exchange equity finds that individuals who report attitudes of tax resistance have negative feelings regarding the quality of benefits received in exchange for their tax dollars.⁵⁸ Taxpayers who admit to previous evasion and taxpayers who indicate a willingness to evade have negative perceptions of exchange equity.⁵⁹ Results from studies using experimental marketplaces find that subjects are more compliant when they receive benefits in exchange for their tax payments. These studies suggest that a government can increase voluntary tax compliance by offering additional benefits, improving efficiency within programs funded with tax revenue, and reminding taxpayers of the necessity of tax revenue to provide important benefits. A recent study finds that exchange equity is the most important dimension of overall equity as taxpayers consider the fairness of a tax system.⁶⁰

C. Criticism of Equity Theory

Collectively, distributive justice research supports the importance of fair outcomes in a tax context. Compliance suffers when principles of horizontal, vertical, and exchange equity are violated. However, an overreliance on equity theory to explain the relationship between fairness and compliance has been criticized.⁶¹ Critics argue that tax studies examine fairness because deterrence theory, rooted in economic self-interest, cannot explain the high levels of observed voluntary compliance.⁶² However, an emphasis on distributive justice implies that taxpayers are concerned primarily with their personal self-interest as they form fairness judgments and make compliance decisions. Studies demonstrate that individuals do not always focus on their personal outcome while considering the fairness of the tax system.⁶³ These studies suggest that equity theory alone is insufficient to describe the process by which taxpayers form overall fairness perceptions.

Studies criticizing an emphasis on distributive justice suggest that the definition of fairness must be expanded to include factors other than one’s personal tax burden. The evolution of the justice literature establishes that equity perceptions are driven by more than just distributive justice. Studies demonstrate that in addition to distributive justice, procedural, interactional/interpersonal, and informational justice are important underlying dimensions that form one’s overall fairness judgement.⁶⁴ In a tax context, individuals consider several aspects of fairness: (1) the evenhandedness of the tax authority’s procedures (procedural justice), (2) the adequacy of explanations from tax authorities (informational justice), and (3) the (respectful) treatment they receive from the tax authority (interactional/interpersonal justice).⁶⁵

D. Procedural Justice

Procedural justice studies demonstrate that fairness of process is distinct from the fairness of one’s outcome;⁶⁶ individuals display concern regarding fairness of process that is independent of their judgments regarding the distribution of outcomes. Favorable procedural justice perceptions improve the acceptance of an outcome, even when the outcome is unfavorable. Research suggests that individuals adopt procedural justice rules, or norms, that define a fair process.⁶⁷ As individuals consider a procedure, they compare their actual experience with these norms to determine whether the process is fair. The following rules suggest a fair process: (1) consistency — procedures are consistent across individuals and over time; (2) bias suppression — the authority enforcing procedures act free from personal self-interest; (3) accuracy — outcome allocation is based on accurate information that is processed with a minimum of error; (4) correctability — procedures allow for legitimate avenues to challenge decisions, and modifications and decision reversals are granted when appropriate; (5) representation — outcome allocation reflects the concerns and well-being of subgroups in the population; and (6) ethicality — procedures reflect and are compatible with the prevailing moral and ethical values of the population.

Aside from distributive justice, procedural justice has received the most attention within the tax compliance literature. Researchers have argued that strategies that improve perceptions of procedural justice may result in persistent, long-term compliance behavior.⁶⁸ Studies suggest that taxpayers who experience or perceive procedural justice (rather than injustice) view the tax authority as more legitimate, leading to more honest tax reporting.⁶⁹

Most tax compliance studies examine a single procedural justice rule. For example, a positive relationship between representation and procedural fairness perceptions has been observed.⁷⁰ If individuals believe that lawmakers consider their opinions about a proposed tax law change, they rate the process by which the new law is selected as fair, even when their preferred policy isn’t enacted. This relationship, however, is moderated by preference intensity. Representation doesn’t affect perceived equity for subjects that are passionate about their preference. This study suggests that as taxpayers feel more strongly about their preferred tax policy, procedural justice concerns become less important and outcome favorability drives equity judgments.

Providing more support for the importance of representation, research participants in an experimental lab setting respond with increased compliance when they have control over how tax dollars are spent.⁷¹ Compliance levels are significantly higher when individuals vote on the use of their tax dollars, even when compared with conditions in which identical benefits are provided but are imposed on subjects. Voluntary tax compliance suffers when subjects are unable to vote on the public good and when tax dollars are allocated to unpopular government programs. Compliance is worse when unpopular programs are selected when compared with conditions in which no public good is provided in exchange for subjects’ tax payments. Another study finds that voluntary compliance is significantly higher when individuals vote on the tax structure, even when compared with conditions in which subjects face identical tax regimes but are unable to vote.⁷² These studies support a positive relationship between representation and fairness perceptions and between representation and tax compliance behavior.

Experimental studies provide evidence of a positive relationship between procedural justice and tax compliance, but the results of these studies must be evaluated in light of their limitations. Research conducted in an experimental setting might not generalize to taxpayers as they make personal tax compliance decisions. A recent study using survey data and modeling techniques supports the importance of procedural justice in a tax context.⁷³ The model developed in this study finds that as perceptions of procedural justice increase, individuals display improved tax compliance intentions.

This initial research suggests that the IRS can improve voluntary tax compliance by evaluating the tax collection process to ensure it does not violate procedural justice rules and norms. While most of this work is focused on representation, results are encouraging, and it is reasonable to assume that other modifications to the tax collection process that improve procedural fairness perceptions might also nudge taxpayers into voluntary compliance.

E. Interpersonal Justice

Research establishes interpersonal⁷⁴ justice as a distinct dimension of overall fairness.⁷⁵ Individuals differentiate the treatment they receive from an authority from the fairness of procedures the authority is tasked with implementing. Individuals who have negative interpersonal experiences with an authority may perceive a situation as unfair, even if they perceive the process and outcome as equitable. Like procedural justice, research suggests that individuals hold expectations regarding the treatment they should receive from an authority and form interpersonal fairness perceptions by comparing actual experiences with these normative expectations. In general, individuals expect to be treated with dignity and respect. Applied to a tax context, communications and personal experiences with representatives from the IRS will affect fairness perceptions when taxpayers view the treatment they receive as reflective of the IRS instead of simply a characteristic of the representative with whom they have interacted.

Few studies have examined the relationship between interpersonal justice and tax compliance. Two field studies conducted outside the United States provide contrary results. A study conducted in Ireland found that letters violating interactional justice principles by using “direct, brisk and authoritarian” language increased subsequent tax compliance compared with a standard reminder letter.⁷⁶ A similar study focused on Australian taxpayers reported contrary results.⁷⁷ Letters based on principles of interpersonal justice resulted in increased compliance for the Australian sample. The mixed results from these studies may be attributable to cultural differences across the two samples; it’s unclear how the results of those studies might generalize to U.S. taxpayers.

A recent study using a U.S. sample finds that interpersonal fairness has a positive effect on tax compliance when detection risk is low.⁷⁸ Subjects in this study were most compliant when detection risk was not mentioned, and the tax authority was described as polite and respectful. This result suggests that interpersonal fairness is not a factor in the compliance decision when detection risk is salient. The authors of this study argue that detection risk is such a strong incentive to comply that overlaying interactional fairness on top of a high detection environment has no additional effect on compliance decisions. This research does suggest that positive interpersonal interactions with the IRS will promote improved voluntary compliance when audit risk is low. The audit rate is currently quite low for individual taxpayers; the IRS should consider policies that ensure positive interactions between taxpayers and IRS employees to improve compliance.

F. Informational Justice

Interpersonal justice is further segmented into an interactional component and an informational component.⁷⁹ Informational fairness requires that a tax authority provide accurate and transparent information and explanation to support the process by which taxes are calculated and collected. The tax compliance literature offers support for the importance of informational fairness in improving compliance behavior. Providing justification for a tax law change results in greater acceptance.⁸⁰ Experimental subjects made worse off by a tax law change judged the change to be unfair. However, this effect is moderated by legislative explanation. Subjects provided with an explanation were more likely to judge the law change favorably, even when their personal outcome was unfavorable. Multiple field studies observe increased compliance when tax compliance reminder letters reflect principles of informational justice.⁸¹ This research suggests that improving the quality of information provided by a tax authority will improve tax compliance.

Studies examining the effect of complexity on compliance provide additional support for the benefit of informational fairness in a tax context. Fairness perceptions and complexity have a negative relationship, and, generally, individuals do not feel that the complexity of the tax system is justified.⁸² However, when subjects evaluate specific provisions of the tax law, studies suggest that justification moderates the negative relationship between complexity and fairness. If taxpayers view complexity as justified, fairness perceptions improve. Lab experiments have demonstrated the positive effect of providing helpful information to taxpayers. In an experimental lab setting, uncertainty (caused by complexity in filing requirements and tax calculations) results in an increase in nonfilers and unreported income. However, providing information to alleviate this uncertainty increases the likelihood that a taxpayer will file a return and results in subjects reporting more taxable income.⁸³ Overall, research suggests that a tax authority can promote voluntary compliance by providing adequate and accurate information to taxpayers to assist in the tax compliance process.

G. Equity Conclusion

Research demonstrates that taxpayers are concerned about the fairness of the tax system; voluntary tax compliance improves when taxpayers perceive the system as fair. While changing perceptions regarding the horizontal, vertical, and exchange equity of the current tax system might require changes to the tax law or modifications to the government’s budget, improving perceptions of procedural, interpersonal, and informational justice can be accomplished without legislative action. Moreover, interventions to improve fairness perceptions are likely less expensive than expanded or enhanced deterrence activities. Policymakers should consider interventions to promote the fairness of the tax system when allocating the IRS’s budget to the agency’s various programs.

IV. Conclusion

Much attention has been devoted to understanding the effect of audits and tax penalties on compliance, and rightfully so — these deterrence mechanisms are successful in increasing tax revenue. However, without a significant increase to the IRS’s budget, it will be difficult to increase the audit rate or implement a targeted enforcement program. Also, research suggests that enhanced deterrence efforts should be balanced with policies that encourage cooperation with taxpayers to promote voluntary compliance behavior. Academic research offers insights and suggestions to improve voluntary compliance beyond reliance on an enforcement paradigm.

Regarding deterrence measures, studies suggest that simply increasing the awareness of penalties and interest can improve compliance behavior. This low-cost intervention can be implemented without increasing the audit rate and can reduce the necessity of more costly enforcement efforts to the extent it improves compliance. Beyond deterrence, academic research provides strong evidence that compliance will improve if taxpayers perceive the tax system as fair. Policymakers and the IRS should consider interventions that improve perceptions of procedural, interpersonal, and informational justice. Studies suggest that these interventions can promote compliance even when detection risk is low, which describes the current tax context for most individual taxpayers.

It appears unlikely that the Biden administration will be able to implement its ambitious plan to increase IRS enforcement activities. If the IRS is unable to conduct more audits, it must consider other interventions that nudge taxpayers into compliance. Researchers have been considering possible interventions for years, and the results of their work can provide valuable insight when considering alternative measures to improve compliance behavior.