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Abstract
Underreporting of income is a costly problem for the government and for those people
who do pay their taxes, due to the necessity of higher tax burdens to sustain a
given amount of revenue. An extensive research report published by the IRS this
year estimates that in the United States in 2006 the “tax gap” between paid taxes
and legally owed taxes was $450 billion, which means 16.9 percent of total tax liabilities
were evaded that year (Black et al., 2012). The IRS recovered $65 billion from
late payments and audits, but that still left 14.5 percent noncompliance. Breaking
the tax gap down into finer categories, the IRS finds that the vast majority (84
percent) comes from underreporting of income, most of that (62.5 percent) comes
from individual income taxes, and most of that (52 percent) is small business proprietor’s
income. This totals to 27 percent of noncompliance due to underreporting
of individual proprietor income. It is estimated that 57 percent of business income
is not reported (Black et al., 2012). Wages make up a small fraction of underreporting,
mostly due to the fact that firms must report employee income directly to
the IRS, and withholding is common, so a relatively disinterested third party makes
the decision of how much income is reported (Slemrod, 2008). Slemrod emphasizes
the importance of enforcement in compliance behavior, citing the fact that income
subject to withholding and substantial information reporting (wages) has a 1 percent
noncompliance rate, compared to 56 percent noncompliance for income with little or
no information reporting requirements.
Given the difficulty of identifying cheaters and the cost of increasing the rate
of auditing, a better understanding of the determinants of noncompliance is needed
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to reduce the magnitude of tax cheating. To address a part of the tax evasion
quandary, Kalambokidis et al. (2012) conducted a laboratory experiment1 which
was designed to examine the feasibility of using the choice between a high-burden,2
low-transparency and a low-burden, high-transparency tax regime, as a mechanism
to separate out those who have higher and lower propensities to cheat when reporting
their income. The results are the subject of this paper.