Can interventions from behavioral economics get people to pay their taxes? It is a question of the greatest urgency in Latin America and the Caribbean where evasion of personal and corporate income taxes reaches as high as 50% in many countries, with significant impact on their scope of options.
The short answer is that behavioral interventions can be crucial. As has been shown in field experiments in Argentina, Chile, Colombia and other countries, they can change people’s beliefs about penalties, enforcement and the possibility of detection by tax authorities, and, in some cases, dramatically improve tax compliance.
The importance of spillover effects on tax compliance
But policymakers have to be aware of spillover effects of their interventions. Getting people to pay a single tax is one thing. A country, state or municipality, however, will want individuals to pay the full portfolio of their taxes, ranging from property to value-added and income taxes. Studies, meanwhile, suggest individuals will try to keep their overall spending on taxes constant. So if they declare greater sales following a government nudge to do so, they may also declare greater expenses.
We decided to see how these important spillover effects worked in practice across taxes to evaluate whether if people pay more in one tax they skimp on another. At the IDB we conducted an experiment in Argentina in 2012 in which we tested how changing messages about property taxes could affect compliance. We realized that people often didn’t understand how a seemingly small interest rate on their tax penalty could accumulate. So we provided them with messages that clearly explained how a compound interest rate of 2% in the tax penalty could result in $268 in arrears for a $1000 tax liability by the end of the year. We also provided messages that the government was serious about enforcement. Not surprisingly people became worried, and compliance with regards to the property tax increased by nearly 10%.
A behavioral intervention that affect two taxes at once
Then in a more recent study, we looked at data from the experiment in Argentina and at payments by individuals who owed both property –the originally targeted tax- and gross-sales taxes. We found that our intervention targeting property tax not only increased compliance with that tax. It also had a modest, but significant, spillover effect on the gross sales tax. Indeed, the intervention regarding the property tax caused individuals to pay two percentage points more on their gross sales tax. Because penalties across taxes are the same, the information provided in one tax increased the fears of enforcement and penalties in the other.
But while information on penalties seem to flow from one tax to the another, people may not react the same to the threat of detection, that is to say the possibility that audits will catch up with them. That it turns out can have both positive and negative spillover effects. A belief that authorities with limited resources are concentrating on the property tax might make them confident that authorities won’t focus on the wealth tax, for example. But where authorities are well-funded, a focus on property tax could make people think they are equally serious about wealth and all other taxes, making people reluctant to shirk any tax.
The key lies in ensuring that policymakers understand that interventions should aim at compliance across various taxes and target the full portfolio of taxes an individual owes. After all, it would be of little value to employ an intervention that makes inroads in the payment of one tax only to lose the same amount of revenue in another one. Also essential is ensuring that the messaging gets individuals to understand that enforcement, penalties and detection are real and that certain types of messages are transmitted better across taxes than others.