The classic approach to reducing tax evasion is to increase the probability of being detected and to increase penalties. However, in a new study, we show that moral motivation is important for tax compliance, and that a moral appeal in a letter from the tax authorities substantially reduces tax evasion. We find that the moral letters had about the same effect on the average as the detection letter. However, the effect of the moral letters comes from a smaller group of taxpayers than the effect of the detection letter. We also considered the long-term effects of the letters and found that only the detection letter had lasting impact on taxpayer behavior.
Tax evasion is a key societal challenge and causes considerable losses in government revenue. In the U.S., these losses are estimated to be about $500 billion, roughly the size of the federal government’s annual deficit.
How can we ensure that people report their income correctly? The classic approach to reducing tax evasion is to increase the probability of being detected and to increase penalties. However, if people are motivated by a desire to do the right thing, moral appeals could also contribute to increased tax compliance. In a new study, we show that moral motivation is important for tax compliance, and that a moral appeal in a letter from the tax authorities substantially reduces tax evasion.
To study the effect of moral appeals, we conducted a field experiment with the Norwegian Tax Administration on more than 15,000 taxpayers. The tax administration knew that these taxpayers were likely to have underreported foreign income in the previous tax year. These taxpayers were randomly assigned to either a control group that did not receive any letter or to different treatment groups that received some letter from the tax administration just before they were to self-report their foreign income. Some taxpayers received a “base letter” that only contained information about why and how to report foreign income, while others received a “moral letter” or a “detection letter.”
We studied two different moral arguments for why people with foreign income should report their income correctly: a fairness argument and a societal benefit argument. We developed two kinds of moral letters out of these ideas. The fairness argument stated that the large majority of taxpayers report their Norwegian incomes correctly and that it is therefore fair that taxpayers with foreign income do the same. The societal argument highlighted the fact that tax revenues finance important public goods. The detection letter did not include any moral appeal, but rather a sentence that emphasized the possibility of being audited.
We found that the base letter itself increased self-reported foreign income, which suggests that some of the initial underreporting was related to lack of information and knowledge about how to properly report. Strikingly, however, the average amount of self-reported foreign income by the taxpayers who received one of the moral letters was almost double the amount self-reported by those who received the base letter. Taxpayers who receive the moral letters on average self-report $1,300 more in foreign income than taxpayers who received the base letter. We did not find any statistically significant difference between the amount of self-reported foreign income between those who received the letter with the fairness argument or the letter with the societal argument.
Interestingly, we find that the moral letters had about the same effect on the average as the detection letter. However, the effect of the moral letters comes from a smaller group of taxpayers than the effect of the detection letter. Whereas the detection letter worked by substantially increasing the share of taxpayers reporting a positive amount of foreign income, the moral letters worked by increasing the self-reporting behavior of a smaller number of taxpayers, but by a larger amount. We also considered the long-term effects of the letters, in terms of how much the taxpayers self-reported one year later. We found that only the detection letter had lasting impact on taxpayer behavior.
A large literature in psychology and behavioral economics have shown that people are willing to trade off between self-interest and moral considerations in laboratory situations with small stakes. Our study shows that moral motives also matter in natural settings with large stakes. This insight is important both for policymakers thinking about tax avoidance but also more broadly. Our research suggests that moral appeals should be part of the toolkit for any organization in which compliance is an important challenge.
Moral appeals can often be cost effective, but our evidence suggests they must be applied carefully. They seem to work best in the moment, without longer-lasting effects. And they may not be universal in reach. They may matter only for morally-motivated individuals. However, for those individuals they can be quite effective. By coupling moral appeals with other measures like the threat of detection, decision-makers can better ensure compliance, including limiting tax evasion.
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