Latin America and the Caribbean has faced several consecutive crises, from COVID to the Russian invasion of Ukraine, that have weakened countries’ ability to provide their citizens goods and services and underscored the need to increase rates. Budgets are tight and capital spending meager, and the region can’t afford rates of evasion for personal and corporate income taxes that, in many countries, ascends to 50%. Moreover, in an already very unequal region, tax evasion tends to increase inequality.
The challenges of improving tax collection, however, are immense. Labor informality is very high, so many people are not registered with tax authorities. Tax agencies lack the resources to carry out their job well, particularly at the subnational level, and the tax codes and forms can be confusing and complex, reducing the ability of people to pay.
Nudging Can Make Tax Compliance Simpler
Amid these challenges, tax collection can significantly improve if compliance is made simpler and the cognitive costs of doing so reduced. As we know from behavioral economics, people have limited attention spans, and even those whose intentions are honorable may ultimately fail to pay if the process overly stresses their ability to focus and comprehend.
When asked the reasons they don’t pay, for example, people often say “nothing happens if you don’t pay,” “nobody else pays”, and “the government misuses public monies.” Sometimes these beliefs are accurate, but people also frequently believe that some behaviors are more or less common than they actually are. They may hear that somebody didn’t pay their taxes and assume that nobody does. They may read about a corrupt politician and assume that all politicians are corrupt. In such situations, there are ways to provide information and design interventions based on behavioral economics to correct mistaken assumptions. Changing such beliefs is a challenge, but not an insurmountable one.
A New IDB Report on Behavioral Insights
Here at the IDB, we have developed extensive expertise on tax compliance, which we summarize in our latest publication that presents the lessons learned from 10 years of applying behavioral insights in Latin America and the Caribbean.
One lesson involves tax registration. In order to collect taxes, governments need to have an up-to-date taxpayer registry. Online registry and service platforms can make it easy to register, but few taxpayers use them. That was the case in Fortaleza, Brazil. So in collaboration with the IDB, the tax administration of Fortaleza ran a project focused on behaviorally inspired, low-cost strategies to update registry information through the online platform. The officials in Fortaleza designed two different email communications both of which provided a morally persuasive message and a clear deadline, and, in one case, participation in a lottery for the taxpayers who registered. These messages increased enrollment between two and half and three and half times compared to a control group that received no email. Based on the results of the study, tax administrations would be well-advised to use a layered approach (that takes into account the beliefs and differences among taxpayers) to increasing registration. Prompting voluntary registration through emails can be a cost-effective intermediate step. It could be complemented with a mixture of communication methods and the targeting of different types of taxpayers, considering heterogeneous effects according to age, gender, compliance status, and property values.
In a study in Argentina, we embedded behaviorally-informed messages directly into tax bills, instead of sending a separate letter. Taxpayers were nudged by one of three different messages: the first stated the penalties associated with not paying taxes; the second, the public works made possible by taxes; and the third, the moral obligation to pay them. The most effective message was the first one having to do with penalties: It achieved a 9% increase in compliance.
Changing the communications methods can also be useful. Taxpayers may not react the same to a letter (the most traditional communication method used by tax administrations), an email, a phone call or a simple knock on the door to remind them to pay their taxes. In a couple of projects we carried out in Colombia with the national tax authority, we kept the messages constant while varying the communication channels. The national tax authority sent messages with the same content through letters, emails, phone calls and personal visits. The personal methods (visits and a phone call) were more effective than the impersonal ones, and among the more impersonal ones, the email was more effective than the letter.
Rewarding Citizens for Paying their Taxes
Another study, explored a different approach: actually rewarding citizens for paying their taxes. Offering rewards can be an important tool. It can change perceptions and beliefs, and, as a result, behavior. Of course, the particular design of rewards programs is key to their effectiveness (plenty of them do not work). In a municipality in Argentina, the government randomly chose citizens among the more than 72,000 who were up to date with their taxes to receive an award in the form of a sidewalk built in front of their home. Once the sidewalks had been built and citizens could witness the government’s effective use of public money, tax collection improved: Those who received the sidewalks were 7 percentage points more likely to pay their taxes on time during the following three years. The changes in behavior among the winners’ neighbors were even more impressive: There was a “contagion” effect from those who paid their taxes and a lasting spillover one. That is because delinquent taxpayers changed their beliefs both with respect to the compliance of their neighbors and the use of public money by the government. Areas where there had been a deficient provision of public services—making new sidewalks stand out in contrast—showed especially large payment increases. Delinquent taxpayers who were neighbors of the sidewalk winners were 7.5 percentage points more likely to pay on time; 10 percentage points more likely to pay three months late; and 15 percentage points more likely to pay at some point, and these results held up over the long term. Indeed, rewarding taxpayers for good behavior with a durable and visible public good has positive effects.
Tax collection is one of the most vital and difficult functions of government, essential to keeping the provision of essential goods and services flowing to citizens. It is also an area where Latin America and the Caribbean has struggled. Interventions from behavioral economics can make it easier for governments—and like so many of the interventions described in our new publication in areas ranging from education and gender to health and pensions—help make life better for the people of the region.