Endogenous audits, uncertainty, and taxpayer assistance services: Theory and experiments

Abstract

In recent years there has been a sharp rise in the information available to individual income taxpayers, such as through tax preparation software provided by third parties and support available by tax agencies, but the effects of this information on tax reporting are not well understood. Within a setting characterized by an endogenous audit process and taxpayer uncertainty, this study uses theory and laboratory experiments to investigate the effects of taxpayer assistance services that better inform taxpayers about their tax liability and the audit process. The endogenous audit rule we study is simple, yet relative to existing work is more likely to characterize the actual incentives facing taxpayers. Among our findings, and in contrast to the case of purely random audits, in theory the effect of providing more accurate information on tax liability is ambiguous, and we find support empirically for increased tax underreporting even in a setting where theory predicts the opposite. This unanticipated result is mitigated when services provide better information on both liability and the audit process, suggesting that audit information may be more salient to participants.