In Search of… tax edition

Back in the late 70s there was this excellent TV show narrated by legendary Leonard Nimoy called In Search of…. The show was devoted to mysterious phenomena like the Bermuda Triangle and the Loch Ness Monster. This also seems fitting for the topic of taxes, which many people also find mysterious. And since tax season is once again upon us, it seems like a good time to talk about taxes.

When it comes to models of tax compliance, the models are typically based on a rational individual (someone who makes decisions that makes them the happiest) who weighs the benefits of tax compliance against the risks and costs of tax noncompliance. That is, the act of tax compliance is a strategic decision. What I do not like about this standard set up is that it ignores many factors that affect taxpayer compliance, notably knowledge and information both of which are very costly to acquire. Clearly, an individual’s knowledge about taxes influences their ability to comply with tax rules. Most of the existing research on tax compliance takes knowledge and information as given, which is grossly naive.

There is ample anecdotal evidence that suggests that taxpayers struggle to understand and comply with tax regulations. In some cases this leads to underpayment, but which can also lead to overpayment, an oft overlooked problem in tax compliance.

There is some research that has begun to examine this problem.  In a study conducted in Australia, McKerchar (1995) found that small business taxpayers may be unintentionally non-compliant because they are unaware of their own shortfall of taxation knowledge. In other words, they did not know what they did not know. More recently, Hoopes, Reck, and Slemrod (2013) examined the acquisition of tax information and find that taxpayers do attempt seek information around tax time in an attempt to comply with their tax obligations. This search for information is important since Fallan (1999) found that improved tax knowledge significantly changed attitudes toward the fairness of the tax system. Finally, Chetty, Friedman, and Saez look at how differences in knowledge influences the Earned Income Tax Credit refund and earnings in the US.

I personally wonder whether tax software helps or hinders taxpayer knowledge. Modern software asks the taxpayer simple questions to generate their return. I shudder at the thought of a taxpayer blindly clicking through these questions without taking the time to understand the relationship to their tax position. For example, I have to wonder how many taxpayers think they benefit from the Child Fitness Tax Credit because they claim these expenses, but fail to understand because the credit is nonrefundable they actually derive no benefit at all from the credit because of their tax position.

Overall, there is currently little academic understanding of not only the role of knowledge and information on tax compliance, but also how tax payers seek information and the quality of the information they obtain in their quest to be compliant as well as the relationship on compliance. This is a ripe area for a budding scholar, particularly for a PhD dissertation, particularly one not afraid of qualitative research methods.

McKerchar, M., 1995, ‘Understanding Small Business Taxpayers: Their Sources of Information and Level of Knowledge of Taxation’, Australian Tax Forum, Vol.12 No.1, pp.25-41.

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