Tax administrations increasingly use techniques typical of economic psychology to analyze the behavior of citizens and improve tax compliance. Behavioral economics makes it possible to use tools to reduce psychological biases which may lead to tax non-compliance, and can also use information to change taxpayers’ views, and thus encourage voluntary compliance.
Among these tools are the “nudge” techniques that are aimed at encouraging correct tax behavior and are based on the “behavioral insights” approach, that is, an approach towards a better understanding of taxpayer behavior. Small positive shifts in this behavior can lead to significant additional revenue, and this article sets out to show how the use of behavioral insights can influence the behavior of taxpayers to help deliver these shifts.
In a 2020 survey conducted by the Organization for Economic Cooperation and Development (OECD) Forum on Tax Administration (FTA) 73% of respondents agreed that behavioral insights were part of their organization’s current strategy: Overall, around one-third of FTA members are using behavioral insights.
A recent OECD report, “Behavioural Insights for Better Tax Administration: A Brief Guide,” includes strategic considerations as well as a high-level discussion of the methods employed by behavioral scientists.
The report also provides concrete examples of how behavioral insights have been used in tax administration, and highlights prospective uses and strategic considerations. Finally, the report sets out some practical guidance for tax administrations considering developing the use of behavioral insights.
Application of Behavioral Insights
Behavioral insights can be beneficially applied to inform a suite of options for achieving strategic goals, such as improving compliance behavior in a range of situations. This leaves senior decision-makers better positioned for selecting the most viable course of action, whether it is a distinct intervention or a complementary set of approaches.
According to the OECD report, interventions involving behavioral insights have helped tax administrations in different jurisdictions:
- reduce the number of taxpayers owing taxes through behaviorally informed changes to processes, by as much as 33%;
- improve timely personal income tax payments with low-cost changes to communications, significantly increasing revenue collected and debts prevented;
- reduce misreporting of income and expenses through tailored digital prompts;
- reduce improper payments of benefits to ineligible taxpayers;
- increase voluntary disclosures and reporting of wealth by as much as 30%;
- increase filing among prior non-filers by as much as 15%;
- increase self-service and online reporting by more than 20%.
Experiences in Different Countries
In Colombia, personalized messages were developed that included information about the taxpayer’s debts, payment methods and the cost in terms of interest and other penalties that the taxpayer could incur if they continued their behavior. The message “Colombia, a commitment we cannot evade” was also included as a moral call to civic responsibility.
Experiments showed that messages sent by personal contact methods tended to be more effective than impersonal ones. While eight out of 100 people who received a letter paid their debts, the figure doubled in the case of those who received an email. Phone calls increased the success rate to 30 out of 100 people, and personal visits were by far the most successful, with nearly nine out of 10 people deciding to change their behavior and meet their tax obligations.
In Latvia, the impact of sending emails containing various types of messages was measured and it was found that highlighting non-compliance as a deliberate choice was the most effective way to increase the submission of tax returns.
In Poland, letters were sent to defaulting taxpayers with different messages, highlighting social incentives such as the public good and social norms, emphasizing penalties for non-compliance, or emphasizing non-payment of taxes as an intentional choice. It was found that the messages significantly improved tax compliance in relation to the status quo letter.
In Belgium, simplified letters were sent, and where the consequences of non-compliance, such as fines and tax increases and/or enforcement of controls, were made explicit, this led to higher rates of tax compliance; while moral messages promoting social norms had no impact and sometimes decreased compliance.
In Germany, it was also revealed that simplifying tax notification letters and highlighting the possibility of sanctions can increase taxpayer compliance.
One study in the U.S. evaluated how audits of self-employed taxpayers impacted future compliance. The results suggest that audits with adjustments can have persistent positive impact on future compliance, but audits may carry negative long-term consequences when they do not detect any non-compliance. The previously non-compliant taxpayers began reporting higher taxable incomes which continued for three years after the audit (on average, 120% more). In contrast, those without an adjustment reported around 35% less taxable income than the control group in future years.
In the U.K., several experiments were also carried out on this topic. In one of them, 100,000 letters with six different messages were sent. It was concluded that the use of social norms through short messages is effective in pushing people to a behavior. Another experiment related to reducing the cost or inconvenience of filling out forms to pay taxes. Initially, a letter was sent and added the web page on which the form could be downloaded, achieving a response rate of 19%. The intervention consisted simply of adding a direct link to download the form, causing a response rate of 23%.
The Hungarian National Tax and Customs Administration sent reminder letters to self-employed entrepreneurs about their upcoming value-added tax (VAT) filing date. On average, receiving a reminder letter increased the filing rate by five to six percentage points. The effects were highest among taxpayers who had not complied with the deadline in previous years. The experimental design also showed significant spill-over effects—other clients of such taxpayers’ accountants also showed improved VAT filing.
The Dutch Tax and Customs Administration sought to reduce the level of non-filing with targeted letters. The letters contained information that the administration knew about the taxpayer’s foreign bank account(s), and provided a period to file without fines. These messages increased the credibility of enforcement, incentivized early filing to avoid fines, and communicated norms by highlighting that many others had already filed. The methods successfully increased voluntary disclosures.
Tax Norway conducted survey experiments about how the economic impact of the Covid-19 pandemic can influence support for economic relief programs, trust in tax administrations, and attitudes towards evasion. One of these studies showed that adding a single sentence about fewer on-site audits caused a statistically significant reduction in support of the Business Compensation Scheme by 5.6 percentage points (compared to baseline support of 80%) as well as a 10% decrease in perceived detection rates and a 14% reduction in trust in the tax administration’s abilities.
Other Measures to Improve Compliance
In addition to the behavioral insights discussed here there are obviously many ways to improve tax compliance and it is clear that the tax authority must work on permanently reducing the compliance costs that taxpayers face and also on the costs of administering the tax system.
Other measures to promote tax compliance include:
- simplification of the rules and procedures of management;
- provision of tax data;
- draft declarations;
- pre-filled or pre-completed returns;
- payment facilities and postponements;
- management of refunds;
- measures of cooperative compliance, as in the codes of good practice or forums of companies and professionals.
The digitalization of tax authorities can certainly also improve tax compliance, making both the functions of services and control more efficient and above all introducing transparency in the relationship with citizens, thus providing certainty.
Tax authorities now set prevention of fraud as a strategic objective, in addition to the fight against tax fraud. This requires the design of a comprehensive assistance strategy that manages to reduce the administrative burdens faced by taxpayers and promote voluntary compliance with tax obligations and, with this, prevent non-compliance.
It is very important to facilitate taxpayers who want to comply by offering comprehensive information and assistance, provided by qualified personnel, where all areas of the tax authority are aimed at the goal of reducing compliance costs.
Human behavior underlies many challenges facing tax authorities, from improving taxpayer compliance to ensuring positive taxpayer interactions. The introduction of behavioral science has shown how these perspectives can improve outcomes and produce actionable insights that can aid in designing processes and solutions.
In short, the digital transformation of tax authorities must be approached in a holistic way, redefining the processes, orienting the services to the citizen, and, of course, establishing a strategy that combines a citizen-centered approach with a more efficient, interconnected, collaborative model, adapted to social reality.
It is important to emphasize that there is no single solution or magic to achieve voluntary compliance; however, it is possible to talk of best practices that have been successful in certain countries, while acknowledging the fact that it is also very important that the implementation takes the context of the relevant country into consideration.
It is essential to work to achieve widespread social acceptance of the tax system, since without this acceptance it is very difficult to apply such a system.
This column does not necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.
Alfredo Collosa is a consultant and tutor in Tax Administration at the Inter-American Center of Tax Administrations (CIAT), professor, investigator, author of books and publications, and lecturer. He holds an Official Masters in Public Finance and Tax Administration (UNED-IEF).
The author may be contacted at: email@example.com