Program Profile: Tax Compliance Experiment (Israel)

A Tax Compliance Experiment was conducted in Israel and sought to test whether taxpayer compliance could be increased by mailing two different types of letters to incorporated taxpayers: a deterrent letter or moral persuasion letter. The program is rated No Effects. There were no statistically significant differences between the corporate taxpayer treatment groups and the control group in the likelihood of paying taxes or the likelihood of accurately reporting tax deductions and gross sales.

A No Effects rating implies that implementing the program is unlikely to result in the intended outcome(s) and may result in a negative outcome(s).

This program's rating is based on evidence that includes at least one high-quality randomized controlled trial.

Program Goals

A Tax Compliance Experiment was conducted in Israel and sought to test whether taxpayer compliance could be increased by mailing two different types of letters to incorporated taxpayers: a deterrent letter or moral persuasion letter. The program is rated No Effects. The deterrence and moral persuasion approach did not significantly impact corporations’ likelihood of paying taxes, accurately reporting gross sales, or accurately reporting tax deductions.

Program Theory

The experiment was based on the deterrence model, as well as the moral persuasion model. The deterrence model is based on the belief that effective threats of detection and punishment for noncompliance will increase compliance. It is argued that taxpayers are rational beings who weigh the costs and benefits of their actions, focusing on ‘”what will make [them] better off” (Ariel 2012, p.28; Akers 1998; Becker 1968). Therefore, through threatening apprehension and punishment, the cost of noncompliance increases, which makes taxpayers more likely to comply.

The moral persuasion model is based on the belief that compliance is gained through appealing to the individuals’ morale, arguing that normative support is sufficient to sustain compliance. It is believed that taxpayers are law-abiding citizens who are not seeking to increase their economic utility through noncompliance: these citizens understand their moral and social obligations and therefore choose to comply with tax regulations (Ariel 2012; Wenzel 2001).

Target Population

Incorporated entities make up 35 percent of the Israeli business community. Thus, the intervention sought to target corporate taxpayers. Incorporated taxpayers pay more than double the amount of tax dollars than unincorporated taxpayers pay; therefore, the ability to impact tax noncompliance for corporations could result in a large gain for governments (Ariel 2012).

Program Components

Seeking to deter tax noncompliance through the threat of punishment, the deterrent letter explained that not filing a tax report or filing one with “irregular transactions” would result in punishment. The types of punishments were explained in the personalized letter, which ranged from fines to criminal prosecution. The deterrent letter also informed recipients that the tax authority had introduced new methods to audit taxpayers. It was believed that adding a message about new methods to audit taxpayers, in a personalized format, would increase the recipients’ perceived risk of detection and apprehension.

Alternatively, the other type of letter sent to taxpayers, a moral persuasion letter, sought to increase tax morale. The moral persuasion letter did not mention the punishments of tax noncompliance. Instead, it emphasized the consequences of not paying taxes. The letters informed recipients that tax dollars are used to finance public commodities, stressing how their taxes were essential in the process.

Study

To examine the impact of the tax letters on corporate tax compliance, Ariel (2012) conducted a randomized controlled trial between January 2006 and March 2007. The sample was drawn from the list of all corporate taxpayers in Israel, which was provided by the Israeli Tax Authority. There were no major inclusion restrictions; however, there were three major exclusion criteria. First, taxpayers who were under investigation for tax evasion during the evaluation period were excluded from the sample. Second, new businesses (defined as 2 years old or younger) were excluded. Finally, 500 companies with the highest revenues in the market, and companies whose stocks were traded in the stock exchange were also excluded. Overall, 4,395 corporations were eligible to participate.

Corporations were randomly allocated into the three arms of the trial: deterrent letter, moral persuasion letter, and no-treatment control. The deterrence group comprised 731 corporations, 732 corporations were allocated to the moral persuasion group, and 2,932 corporations were allocated to a no-treatment control group. The mean gross income of the deterrence group was $772,820, the mean gross income of the persuasion group was $943,613, and the mean gross income of the control group was $843,974. Most of the corporations had their main offices in large metropolitan cities in Israel. Real estate was the most prevalent market sector, followed by construction workforce, consultancy firms, engineering services, and restaurants.

Tax compliance was measured through gross sales, tax payments, and tax deductions, as these items are needed for tax reports. Gross sales are defined as the total value of services produced or goods sold by a company during the tax period. Tax payments are required from all taxpayers on every transaction the company is involved in during the tax period. Tax deductions are expenses or items that can be deducted from the revenue that is subject to tax. Tax compliance for all three groups was investigated using tax reports following the treatment (January – April 2007) compared with tax reports prior to the treatment (January–April 2006). The following outcomes were measured: effects of deterrence approach on tax payments, effects of moral persuasion approach on tax payments, effects of deterrence approach on gross sales reporting, effects of moral persuasion approach on gross sales reporting, effects of deterrence approach on tax deductions, and effects of moral persuasion approach on tax deductions. No subgroup analysis was conducted.

These sources were used in the development of the program profile: