amazing grace: tax amnesties and compliance - National Tax ...

National Tax Journal, Vol. 43, no. 1, (March, 1990), pp. 23-37

AMAZING

GRACE: TAX AMNESTIES

AND COMPLIANCE***

JAMES ALM,* MICHAEL McKEE,* AND WILLIAM BECK** ABSTRACT

a one-time amnesty may increase future compliance if it is accompanied by greater expenditures for enforcement and stronger penalties for evaders. Critics contend that the long run consequences of an amnesty are more likely to lead to a significant negative impact on voluntary compliance. They present several arguments to bolster their case. First, honest taxpayers may perceive the amnesty as special treatment for tax cheats. If the honest taxpayers resent the tax break given to evaders and conclude that the amnesty is unfair to them, then their compliance may decline. Second, individuals may not believe that the amnesty is a one-time opportunity to repay taxes. If they anticipate future amnesties, then compliance may again decline. No work to date has been able to resolve these fundamental issues. Most of the discussion of amnesties has focused upon the details of their administration.' There has been some theoretical analysis of individual behavior under an amnesty,' and, as information from the state programs has become available, there has also been examination both of the characteristics of those who participate in amnesties and of those amnesty features that lead to greater revenues.' However, these studies have not been able to examine the central issue on the desirability of amnesties: how do amnesties affect voluntary tax compliance in the long run? The major difficulty here is the absence of any field data on the post-amnesty impact upon such things as taxpayer expectations of future amnesties or taxpayer perceptions of fairness. By its very nature, existing information on amnesties must examine the features of an amnesty, the revenues that it generates, and the types of individuals who participate. Field data simply do not exist to examine the long run effects of an amnesty. The purpose of this paper is to use experimental methods to analyze the long run impact of an amnesty on voluntary

Does a tax amnesty raise or lower compliance over time? This paper uses experimental methods to analyze the long run impact of an amnesty. The results indicate that the average level of compliance falls after an amnesty. However, a well-designed amnesty may be able to overcome this decline. If post-amnesty enforcement efforts increase, then aggregate comp,iiance actually increases. In fact, post-amnesty compliance is higher when an amnesty is accompanied by increased enforcement efforts than when enforcement increases without an amnesty. An amnesty may therefore be an effective tool for easing the transition to a tougher tax regime.

1. Introduction ELEAGUERED by declining tax revBenues and mounting expenditures, many state governments in recent years have sought alternative and novel revenue sources. One approach that has been used by twenty-eight states since 1981 is the tax amnesty. An amnesty typically gives individuals an opportunity to pay previously unpaid taxes without being subject to the penalties and prosecution that the discovery of evasion normally brings. Some states have generated large amounts of revenues with their amnesties; New York collected $401 million, and California, Illinois, and Michigan each obtained more than $100 million. Other states have not been as successful. Amnesties in North Dakota, Idaho, Texas, Kansas, and Missouri each collected less than $1 million. Tax amnesties are a controversial rev enue tool. Of particular concern is their long run impact on voluntary tax compliance. Advocates of amnesties argue that *University of Colorado, Boulder, CO 80309. **United Air Force Academy, Colorado Springs, 80840.

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compliance. The laboratory setting captures the essential features of the tax system of the states. Individuals receive income, they pay taxes on income voluntarily reported, they face a probability of audit, they pay a penalty on taxes not disclosed if they are detected cheating, and they receive a public good whose amount depends upon the tax payments of all individuals. A tax amnesty is then introduced, in several alternative ways. In one treatment, an amnesty is offered in the middle of the experiment with no advance waming; in other treatments, individuals are told at the beginning that there may be an amnesty at some point in the experiment; the actual features of the amnesty are also allowed to vary in different treatments. The use of laboratory methods therefore allows generation of data on how individuals comply before, during, and after an amnesty. In doing so, experiments allow analysis of the long run effects of an amnesty in a controlled environment, and so overcome the problems with field data. The results indicate that some-but not all-of the concerns of amnesty critics have foundation. The average level of compliance generally falls after an amnesty is given, and this decline is most likely due to taxpayer expectation of a future amnesty. It also appears that govemment assurances of no future amnesties do little to lessen this effect of expectations on compliance. However, there is mixed evidence that there is a post-amnesty decline in compliance by those who complied with the pre-amnesty regime. Those who had a very high compliance rate before the amnesty continued to comply with the tax; however, those who had moderate pre-amnesty compliance rates lowered significantly their compliance after the amnesty. Moreover, a well-designed amnesty may be able to overcome the post-amnesty decline in compliance. If post-amnesty enforcement efforts increase, then the results indicate that aggregate compliance does not decline after the amnesty. In fact, compliance is higher when an amnesty is accompanied by increased enforcement efforts than when enforcement increases without

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an amnesty. It therefore appears that an amnesty may be an effective tool for easing the transition to a tougher tax regime. Hypotheses about individual responses to tax amnesties are described in section U. Section HI presents the experimental design, and results are discussed in section IV. Section V summarizes the main conclusions. Il. Amnesties and Individual Behavior Behavioral predictions are based upon several factors that are thought to affect the individual's decision to pay taxes. The first factor is the fear of detection and punishment, as suggested by ex ected utility models of tax compliance. However, as argued by Skinner and Slemrod (1985) and others, it seems clear that detection and punishment cannot explain the tax compliance behavior of all individuals. Given the percentage of tax returns that are audited and the penalties that are imposed on audited tax returns, taxpayers would have to exhibit risk aversion far in excess of anything ever observed for compliance predicted by expected utility theory to approximate actual compliance. Other factors must play a role in the compliance-and amnesty-behavior of individuals, factors suggested by altemative theories of behavior under uncertainty. A second element in the amnesty decision may be the manner by which honest taxpayers perceive the amnesty. If honest taxpayers see the amnesty as a reward for tax cheats, then they may decide that they are exploited by their continued compliance, and compliance will decline following an amnesty. A third factor is the impact of an amnesty on the expectation of another, future amnesty. If taxpayers believe that the amnesty is not a one-time program, then they may lessen their compliance now in anticipation of a future opportunity to repay back taxes. Fourth, individuals may pay taxes because they recognize that taxes are necessary to provide government programs. The expenditure side of the fiscal exchange must also be considered. Finally,


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there are intertemporal and interdependent aspects to tax compliance, elements that suggest that one's compliance decision may depend in part upon the decisions of others over time. The hypotheses that are generated and tested reflect these various factors. The first hypothesis relates to the effect of an amnesty on subsequent tax compliance: Hl: Tax compliance will fall after an amnesty has occurred. The rationale for Hl is that honest taxpayers may perceive the amnesty as unfair, since those who were failing to comply previously are being offered a chance to atone without penalty; in addition, all taxpayers may anticipate another, future amnesty. In both cases, compliance will decline. However, it is of some interest to examine each potential cause of reduced compliance separately: H2: Taxpayers who complied prior to the amnesty will decrease their compliance after the amnesty. of a future H3: The expectation amnesty will reduce compliance. " Note that the anticipation effect" of a future amnesty may arise either if an amnesty has actually occurred or if the taxpayers have some reason to believe that one will occur. However, it is possible that this anticipation effect will decline over time if an amnesty is not actually given. This suggests: H4: The anticipation effect will decline over time. It is also possible that expectations of a future amnesty will be lessened by government assurances that the amnesty, if it occurs, is a one-time only opportunity to pay back taxes: H5: The government can eliminate the anticipation effect by promising that an amnesty will not be repeated. Such assurances may be considered "cheap talk." Although there are more "expensive talk" devices available, such as the constitutional amendment passed in Massachusetts, there is some doubt that there are any truly credible commitments.

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Advocates of amnesties argue that successful amnesties are accompanied by increased enforcement efforts following the amnesty, efforts that increase the probability of audit and the penalty on evasion. If an amnesty is accompanied by these features, then simple models of compliance suggest that compliance will increase: H6: Tax compliance will fall after an amnesty has occurred unless enforcement efforts are increased. Of course, it would be possible to increase enforcement efforts without actually introducing an amnesty, and such efforts by themselves are likely to increase compliance. This suggests an alternative to H6: H7: Any increased compliance following an amnesty with greater enforcement could be obtained with greater enforcement alone. Put differently, the amnesty per se is likely to lessen compliance, and is unnecessary if enforcement is to be increased in any case. The design of the amnesty may affect the amount of back taxes paid during the amnesty itself. R is likely that individuals will pay more back taxes if they know that their evasion is more certain to be detected and penalized following the amnesty. Therefore: H8: The amount of back taxes paid in an amnesty depends upon the post-ammesty regime. If en. forcement efforts are increased and if taxpayers do not anticipate a future amnesty, then more back taxes will be paid. The final hypothesis relates to the public good aspect of the compliance decision, and requires some elaboration. The tax regime in the United States (and in most other countries) relies upon voluntary compliance with penalties for evasion. As a mechanism for the provision of public goods, this system is thought to have the classic prisoner's dilemma structure that leads to zero voluntary provision of public goods as a unique dominant strategy for individuals. There is, therefore, a ten-


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dency toward free riding that has been noted by Samuelson (1954) and supported by the experimental work of Isaac, McCue, and Plott (1985). However, casual observation suggests that the likelihood of complete free riding is somewhat overstated. Instances of voluntary provision of collective goods are widespread. Perhaps based upon these examples, there is much recent theoretical and experimental work that concludes that voluntary provision may be efficient.' This work is based largely upon the recognition that the contribution decisions of individuals are both interdependent and repeated; that is, one individual's decision to contribute depends upon that individual's perception of what others will contribute now and in the future. An individual may therefore think that his or her decision is pivotal to the provision of the good over time, so that free riding is no longer a unique dominant strategy. The relevance of this work for tax amnesties is easily demonstrated. If the tax compliance game is viewed as a one-shot game without interdependence across individuals or over time, then the game corresponds to the prisoner's dilemma structure. The unique dominant strategy of the individual is to report zero income. However, recognition that the game is interdependent and repeated gives a much richer strategy space, some of which includes cooperative strategies. More generally, the compliance decision now becomes a complex multiplayer, multiperiod game for which there is no unique best response strategy. Therefore: H9: The tax compliance game does not play as a prisoner's dilemma game. Instead, an individual's compliance decision depends upon the actions of the other players. The inclusion of a penalty mechanism also provides some assurance to honest taxpayers that evaders will be punished. Experiments to examine these hypotheses are described next. 111. Experimental Design The experimental design replicates the basic structure of the voluntary income

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tax systems in the United States. In each session the subjects are organized into a group of five individuals. The subjects are told that the session will last for an unknown number of periods, called rounds; the actual number of rounds is predetermined, and equals 25. Each person is given an initial endowment of 10 tokens, and told that accumulated tokens will be redeemed for cash at the end of the session at a fixed announced conversion rate. At the beginning of each round, each person is also given an income in tokens; the income is randomly drawn from the interval 2.00 to 3.00 tokens in increments of .25, and the actual amount is known only to the individual. The individual is then asked to declare some or all of this income. Declared income is taxed at the rate of 30 percent, and taxes of all five individuals in a group are paid into a group fimd. The group fund is increased by a multiple of 2 to reflect the consumers' surplus of the public good, and then distributed in equal shares to the five group members. An individual pays no taxes on income that he or she does not declare. However, each individual faces a probability that evasion will be detected and penalized. After all individuals have reported their income and paid their taxes in a round, up to one person is chosen at random for an audit. If a subject is selected for an audit, then the actual and the declared income for the previous five rounds are compared; if the subject did not fully comply, then any back taxes are collected, and a fine equal to some multiple of unpaid taxes is also imposed, Penalties are not added to the group fimd. The probability of audit and the penalty of unpaid taxes are varied in some sessions to determine their impact on compliance. The audit selection is performed using a bingo cage that contains one numbered ball for each subject plus additional balls that determine the overall probability of audit. Balls are placed in and drawn from the bingo cage in full view of the subjects. In those sessions in which an amnesty occurs, the amnesty takes place at the end of round 13. At that point, the subjects are told that they can pay some or all of their


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unpaid taxes for the previous five rounds with no additional fine imposed on the back taxes that they disclose. Like the regular tax payments, the back taxes paid during the amnesty are combined, increased by a multiple of 2, and then distributed in equal shares to the five members of the group. The post-amnesty probability and penalty differ across the sessions. Seven sessions are conducted, and their features are summarized in Table 1. In the first session (Sl, or the "Base Case"), the probability of audit for each subject is .04, the penalty rate on detected evasion of unpaid taxes is 2,' and no amnesty is given. Session 2 is designed to analyze the impact of the amnesty by itself. Here an amnesty is offered without any prior warning after round 13, but the post-amnesty enforcement regime (the probability of audit and the penalty on evasion) is not altered; also, subjects are not told that the amnesty is a one-time opportunity to pay back taxes. Session 3 considers the impact on compliance of an increase in enforcement without an amnesty. At the end of round 13, subjects are told that the probability of audit will increase to .06, and the penalty on unpaid taxes will increase to 4. Most of the successful tax amnesty programs have combined the amnesty with greater enforcement following the amnesty. Session 4 examines the impact of these programs. As with S2, the amnesty is given after round 13 without prior warning; as with S3, the post-amnesty probability of audit and penalty are increased to .06 and 4. Sessions 5 and 6 are designed to consider directly the effect of taxpayer expectations of a future amnesty. In both sessions, it is announced to the subjects in the initial instructions that an amnesty (without greater postamnesty enforcement) may be offered at some point in the experiment. In S5 the amnesty is not given; in S6 the amnesty is given after round 13. An amnesty is also given in the practice rounds of S5 and S6. Session 7 examines the impact on compliance of a promise that no further amnesties will be conducted. Unlike previous amnesty sessions, subjects are told at the time of the amnesty that the am-

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nesty is a one-time opportunity to pay back taxes and that under no circumstances will a second amnesty be given. In all seven sessions the tax rate on declared income is .3, and the multiplier on tax payments to the group fund is 2. An important feature of the experimental design is that the instructions use "neutral" terminology; that is, all references to taxes, audits, declared income, and the like are replaced with neutral words like contributions, checks, disclosed income, and so on. It is a central tenet of experimental economics that neutral terms be given in instructions in order to avoid context effects. Previous experimental work on tax compliance has used instructions that place the experiment squarely in the context of tax evasion. 7 As noted by Plott (1987) and others, results of such experiments may be biased because the subjects' responses may reflect the values they associate with such words as "audit," "compliance," or "tax evasion," rather than the rewards or penalties that they face in the experiment per se. Since the experimenter is only able to control the latter, it is essential that the institution be described in neutral terms. The instructions are provided in an Appendix (available from the authors). The earlier discussion in the paper uses the tax terminology for ease of exposition." Subjects are volunteers from principles of economics classes at the University of Colorado at Boulder, and have no prior experience in the experimental setting being investigated.'9 Each treatment is replicated three times, and each session lasts approximately one hour. The average payoff per subject is between $15 and $25. All sessions begin with the investigators reading the instructions aloud, while the subjects follow along on their own copies. The subjects retain their copies during the session, and are free to refer to them at any time. Five practice rounds are given, and any detailed questions are then answered; in general, the practice rounds clear up any subject questions. All experiments are conducted in the Laboratory for Economics and Psychology (LEAP) at the University of Colorado at Boulder. This facility has a ded-


28 icated MicroVAX computer terminals, with one terminal monitor.

NATIONAL TAX JOURNAL and sixteen serving as a

IV. Results This section presents the results of tests of the various hypotheses. Data on average compliance rates by treatment are sunanarized in Table 1, which reports the compliance rate as the ratio of declared to total income averaged over all five subjects in all three replications. More detailed data by round are presented in Table 2.'o The hypotheses are tested in several ways. One method simply examines whether the difference in the average compliance rates across treatments is statistically significant using difference of means tests. This method requires that the distributions of the compliance rates in each session be normal and independent. Independence is achieved by pooling the data across the three replications conducted for each experimental treatment; it is these data that are used for the statistical comparisons. Normality is verified with the Bowman-Shelton statistic [Newbold 19881." Hypotheses tests are also conducted using the Mann-Whitney non-parametric test [Conover, 19801, which examines whether two populations have identical means and does not require that the data be normally distributed. Because the results obtained by each of the two methods are the same, only the difference of means tests are discussed in the text. Note that average compliance rates are empirically identical for the first 13 rounds of all seven treatments. Only after a change is introduced in some sessions at the end of round 13 do the compliance rates begin to diverge. Reasons for these differences are suggested by the various hypotheses. The first hypothesis says that compliance will be lower following an amnesty. Sessions 1 and 2 provide some evidence on Hl. Sl is the base case session; in S2 the subjects areoffered an amnesty after round 13 and are not warned in advance that such an amnesty will occur. The average compliance rate in S2 over rounds

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1 through 13 is 0.518, and it falls to 0.449 after the amnesty has occurred, a difference that is statistically significant at the .01 level (t-statistic = 2.60). However, it is possible that compliance simply falls over time during the sessions. For Sl, this is clearly not the case. Average compliance over rounds 14 through 25 is 0.585, which is statistically higher than compliance of 0.532 in rounds 1 through 13 (tstatistic = 1.92). These results suggest that the tax amnesty lowers compliance and that the fall in compliance in S2 is due to the effect of the amnesty and not to the passage of time. Figure 1 shows the round by round compliance rates for Sl and S2. 12 Sessions 5 and 6 also provide some evidence on HI. Recall that in the instructions to these sessions the subjects are told that an amnesty may occur during the session, that an amnesty is included in the practice rounds of these sessions, and that an amnesty actually occurs in S6. The average compliance rate in S5 is only 0.44, which is significantly lower than that in Sl; the average compliance rate in S6 is 0.52, which is also statistically lower than in Sl." The average compliance rate also declines after round 13 in both sessions, from 0.488 to 0.398 in S5 and from 0.556 to 0.486 in S6. In both cases the decline is statistically significant at the .05 level (t-statistics are 3.53 and 1.93, respectively). The second hypothesis looks at the effect of the amnesty on honest taxpayers. Evidence on H2 comes from S2. The fifteen subjects can be classified in one of three groups on the basis of their average compliance prior to the amnesty: group A has very high pre-amnesty compliance (in excess of 80 percent), group B has moderate compliance prior to the amnesty (between 30 and 70 percent), and group C has extremely low compliance rates (close to zero). Except for one individual who reduced compliance to zero, those in group A continued with very high compliance rates after the amnesty, and group C subjects also continued with compliance rates near zero. However, group B subjects generally lowered their compliance. A MannWhitney test indicates that the decline in the compliance rate among this group is


TABLE I EXPERIMENTAL

Session

Enforceme

Announcement of Possible Amn=

Amnesty Given?

DESIGN AND RESU

Promise of One-time AmnesLy?

Ave Rounds 1 --1 0.532 (0.06)

si

Constant

No

No

S2

Constant

No

Yes

S3

Increased

No

No

S4

Increased

No

Yes

S5

Constant

Yes

No

S6

Constant

Yes

Yes

No

0.556 (0.11)

S7

Constant

No

Yes

Yes

0.564 (0.05)

a b c

No

0.518 (0.03) 0.517 (0.07)

No

0.575 (0.07), 0.488 (0.05)

In all cases the tax rate on declared income is .3, and the multiplier on th "Increase(f' enforcement means that the probability of an audit is increase increased from 2 to 4 after round 13. Ile average compliance rate is the ratio of declared income to true inco three replications of each session. Standard deviations are in parentheses


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TAX JOLTRNAL TABLE 2

AVERAGE

COMPLIANCE

RATES

BY ROUND

Session

Round

si Mean

S2 Mm

S3 Mm

S4 Mean

S5 Mm

S6 Mean

S7 Mean

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

0.56 0.56 0.56 0.53 0.42 0.44 0.51 0.64 0.51 0.46 0.58 0.59 0.56 0.58 0.63 0.54 0.53 0.57 0.66 0.48 0.69 0.67 0.58 0.63 0.46

0.58 0.54 0.53 0.51 0.46 0.50 0.55 0.50 0.49 0.52 0.49 0.57 0.49 0.59 0.50 0.54 0.54 0.50 0.45 0.47 0.37 0.31 0.39 0.37 0.36

0.50 0.47 0.62 0.42 0.60 0.52 0.44 0.57 0.62 '0.52 0.49 0.50 0.45 0.56 0.53 0.52 0.56 0.65 0.60 0.64 0.53 0.54 0.50 0.51 0.50

0.68 0.59 0.55 0.63 0.47 0.62 0.50 0.60 0.66 0.51 0.53 0.52 0.62 0.73 0.75 0.63 0.56 0.70 0.69 0.72 0.72 0.60 0.69 0.72 0.72

0.55 0.54 0.54 0.52 0.53 0.49 0.46 0.43 0.43 0.45 0.53 0.47 0.40 0.40 0.31 0.44 0.23 0.31 0.45 0.45 0.40 0.45 0.48 0.45 0.40

0.49 0.53 0.54 0.39 0.37 0.66 0.61 0.62 0.61 0.70 0.68 0.62 0.51 0.63 0.49 0.46 0.49 0.41 0.53 0.53 0.52 0.41 0.51 0.40 0.45

0.62 0.53 0.56 0.55 0.51 0.53 0.52 0.53 0.51 0.68 0.60 0.57 0.63 0.53 0.59 0.53 0.53 0.51 0.44 0.39 0.51 0.53 0.52 0.43 0.56

Total

0.56

OA8

0.53

0.63

0.44

0.52

0.54

significant at the .10 level (z-statistic 1.54). It therefore appears that the negative impact of the amnesty is most pronounced among those who were moderately compliant prior to the amnesty. It is risky to attribute this decline in compliance entirely to taxpayer perceptions of fairness, since other factors may enter. Still, it seems likely that questions of fairness play some role in self-reporting tax systems. The anticipation effect (H3) is tested with data from Sl, S5, and S6. The average compliance rate across all rounds of S5 is 0.44 and 0.52 in S6, both of which are statistically lower than the 0.56 re-

it Was noted above ported in Sl.14 Further, that compliance declines significantly after round 13 for S5 and S6, unlike Sl where compliance tends to rise after round 13. These latter results again suggest that compliance does not necessarily decline over time of its own accord, but rather is affected by the potential for an amnesty. Comparing rounds 1 through 13 of Sl and S5 also provides some support for an anticipation effect. Compliance in rounds 1 through 13 is lower in S5 than Sl (t-statistic = 1.99); however, there is no difference over these rounds for S6 versus Sl (t-statistic = 0.68). H4 suggests that the anticipation effect


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31

Figure I

Compliance Compliance Rate 0.8 0.7 0.6 0.50.4 0.3 0.2 0.1 oi 5 0

10

Rates

15 Round -al

will diminish over time. An indirect test for H4 comes from the results reported for H3, where it was found that compliance in the initial rounds of S5 is higher than in its final rounds, a result in contrast to Sl where the compliance rate does not fall over time. Apparently, hope of an amnesty contributes to a decline in compliance for a considerable time, and the effect does not readily diminish. The effect of a promise that there will be no further amnesties (H5) is tested via S7, in which the amnesty is a surprise, the enforcement effort is not increased subsequent to the amnesty period, and the subjects are told that there could be no further amnesty period. The average compliance rate for the first thirteen rounds of S7 is 0.56 and falls to 0.51 after the amnesty round; this difference is significant at the 0.05 level (t-statistic = 2.67)." (Recall that compliance rose after round 13 in Sl.) Apparently the promise of no further amnesties is not credible. The impact of an amnesty with increased enforcement (H6) is examined by S2 and S4. In both sessions an amnesty is given after round 13; in S4 the probability of detection and the fine on detected evasion are increased. The average com-

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so

a 82 pliance rate in S4 rises from 0.57 to 0.69 following the amnesty, a difference that is statistically significant at the 0.01 level (t-statistic = 4.41). Recall that compliance fell following the amnesty in S2.16 Greater enforcement efforts may therefore be able to offset the negative compliance impact of an amnesty by itself (see Figure 2). These results are also consistent with the anticipation effect. Unless the penalty rate and the audit probability are increased following the amnesty, compliance will decline; however, greater enforcement efforts can mitigate the impact of expectations on compliance. In fact, all subjects in S4 increased their compliance rate after round 13. H7 argues that increased enforcement efforts are sufficient to increase compliance without reliance on an amnesty. Data to test this hypothesis are provided by S3 (where enforcement is increased after round 13) and by S4 (where enforcement is increased following the amnesty in round 13). The average compliance rate in the last twelve rounds of the sessions is higher at the .001 level in S4 (0.69) than in S3 (0.55) (t-statistic = 6.91).17 The data clearly reject H7. It is therefore useful to combine greater enforcement with an am-


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Figure 2

Compliance Rates 0.8

ompliance Rate

0.60.4 0.2 0' 0

5

10

15 Round 82

nesty to generate more tax compliance. Indeed, the amnesty may ease the transition to a new enforcement regime, in a manner that taxpayers perceive as fair. As noted, all fifteen subjects increased their compliance rate following the amnesty in S4; only six subjects increased their compliance after round 13 in S3. The impact of the amnesty design on back taxes paid (H8) is examined with data from sessions S2, S4, S6, and S7. S2, S6, and S7 offer an amnesty but do not increase post-amnesty enforcement; S4 includes both an amnesty and greater enforcement; and S7 includes a promise of no future amnesties. All amnesties generated substantial revenues, in each case greater than the average amount of regular taxes collected per round. However, there is great variation in amnesty revenues. The amnesty in S2 collected 2.40 per group, while average group tax payments in a given round are approximately 2.00; those amnesties in S4, S6, and S7 collected 4.88, 3.80, and 3.99, respectively, per group. Further, if those individuals who owe no back taxes at the time of the amnesty are excluded, then the average of the ratio of back taxes paid by each individual to back tax liability also

20

25

30

& 84 increases significantly in response to the amnesty terms: 0.55 in S2, 0.69 in S4, 0.55 in S6, and 0.66 in S7. These results are broadly consistent with H8. The greatest revenue and the highest amnesty compliance rate both occur in S4, in which the amnesty is followed by increased enforcement; the second highest responses are for S7, in which there is a promise of no future amnesties; and the lowest responses are for S2 and S6-the amnesty compliance rates are identical-where there are no promises and no enforcement increases. Econometric analysis of individual data from S2, S4, S6, and . S7 provides additional support for H8 18 The amount of taxes paid by each individual during the amnesty (BACKTAX) is predicted to be a fimction of the amount of back taxes owed (or the exposure to risk of future audit) at the time the amnesty is offered (TAXOVIED), a dummy variable that equals 1 if there is increased post-amnesty enforcement and 0 otherwise (ENFORCEMENT), and a dummy variable that equals 1 if there is expectation of another amnesty and 0 otherwise (EXPECTATION)." Given the large number of zero observations in the dependent variable,


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Tobit maximum likelihood estimation is used. The results in Table 3 provide limited support for H8. The coefficient on ENFORCEMENT is positive and significant at the 0.05 level. The coefficient on EXPECTATION is negative as expected, but is not significant. Revenues from the amnesty will therefore be greater if taxpayers know that evasion is more likely to be detected and penalized and, to a lesser extent, if they know that subse-

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quent amnesties are unlikely. H9 argued that the individual views the compliance game as interdependent and repeated. The experimental results strongly support H9. For each session, an individual's compliance rate is estimated as a function of the amount of the public good that the individual received in the previous round. In all sessions, the coefficient on the public good is positive and significant at the 001 level, and its mag-

TABLE 3 TOBIT MAXIMUM LIKELIHOOD ESTIMATION RESULTS DtRendent Variable Independent

Variable

BACKTAX

DECLARED

TAXOWED

0.568*** (4.39)

--

ENFORCEMENT

0.532* (1.60)

0.164" (2.09)

EXPECTATION

-0.215 (0.65)

INCOME

0.209"* (6.59)

PUBLIC

0.983*" (10.91)

ANNOUNCEMENT

-0.133*' (2.34)

AMNESTY

-0.131" (2.12)

AMNESTY*ENFORCEMENT Log-likelihood n

t-statistics are in parentheses. Significant at 0.10 level Significant at 0.05 level Significant at 0.01 level

--

0.401** (2.76)

-72.8

-3730.4

60

2625

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nitude is very similar across sessions.'o A nouncement of a possible amnesty (ANmore complete specification of the com- NOUNCEMENT) .23 Also, compliance is predicted to increase as a result of the pliance decision is discussed below. It is of some interest to examine the in- interaction of an amnesty and increased effort (AMNESTY*ENdividual data in more detail. Figure 3 (a enforcement and b) presents the frequency distribuFORCEMENT). Tobit maximum likelition of the individual compliance rates for hood results are reported in Table 3. The results are largely consistent with several representative treatments. In general, there is substantial (though not the predictions. The coefficient on PUBLIC is positive and significant, a result complete) evidence of all-or-none behavior, as would result from a linear payoff similar to the behavior observed in the fimetion for the individual, and compliindividual sessions. Increased enforceance tends to rise or fall across treatment effort by itself increases compliments by changes in the frequencies of the ance; moreover, combining enforcement extreme behavior. Hidden within Figure with an amnesty also leads to increased 3 is some variation in compliance by par- compliance, as shown by the significant coefficient on AMNESTY ticular individuals across rounds. A sub- positive ject apparently may try different strate*ENFORCEMENT. The coefficient on ANNOUNCEMENT is negative and siggies in the compliance game: to induce others to comply, to see the effects of their nificant, indicating that the expectation own tax compliance, to free ride, and so of a future amnesty leads to reduced comon. For the most part, however, there is pliance. This result is also supported by the significant negative coefficient on significant individual consistency across rounds as subjects settle into a predictAMNESTY itself. Having seen an amnesty, the subjects act as if they expect able strategy. another. 24 Figure 3 also indicates that the structure of the amnesty has significant effects on the extremes of the behavior choices of V. Conclusions the subjects. The simple amnesty (S2) results in a considerable fall in the freExperimental evidence indicates that quency of high compliance, while low many-but not all-concems about the compliance rates become much more com- long term effects of a tax amnesty on mon. When the amnesty is accompanied compliance are correct. The overall level by an ex post increase in enforcement (S4), of tax compliance falls after an amnesty. there is a fall in the frequency of the very The decline in compliance stems from the behavior of those persons engaged in low compliance rates and an accompanying increase in the frequency of near com- moderate levels of compliance prior to the plete compliance. amnesty; those who either comply comThe large number of total observations pletely or not at all are largely unaffected across all seven treatments allows esti- by the amnesty. The expectation of an mation of the impact on compliance of amnesty also significantly reduces comvarious institutional variables." The pliance. However, these negative impacts specification is based upon the experion compliance can be offset by greater postmental design (see Table 1) and the lim- amnesty enforcement efforts. More sigited empirical compliance literature.22 It nificantly, the combination of an amnesty is predicted that the amount declared by and enforcement appears to be more efeach individual (DECLARED) is a posi- fective in generating compliance than an tive function of his or her income in a equivalent change in enforcement alone. round (INCOME), the amount of the pub- Compliance may therefore depend to some degree on individuals' recognitions that lic good received in the previous round and that (PUBLIC), and increased enforcement ef- their decisions are interdependent fort (ENFORCEMENT), while complithere is some sort of fiscal exchange. It is here that their perceptions of fairness play ance is likely to fall with the occurrence of an amnesty (AMNESTY) and the an- a crucial role in the compliance decision.



No. 11

AMNESTIES

35

Figure 3 a of Compliance

Frequency 30

AND COMPLIANCE

Rates

requency

25 20 15 10

0,.l

.11,.2 .21,3

.31..4 .41..G .61..6 .6t.7 Compliance Rates

Mala

EM$2a

.91.1

F-134a

Figure 3 b of Compliance

Frequency 40

.71..$ .81..9

Rates

requency

30 20 10 0

O..l

L El .1l..2 .21@3 .3l..4 .4l..5 .51..8 .61..7 .7l..S .81.-0 Compliance Rates =8

Round*14 - 25

lb

MS

2b

r--l 6 4b

.91.1


36

NATIONAL

TAX JOURNAL

[Vol. XLIII

We would like to thmik Norm Frohlich, John Lott, John Baldwin, and three anonymous referees of this Joumal for helpful comments and Doreen Victor for programming work. Partial funding for this work was provided by the Council for Research and Creative Work at the University of Colorado at Boulder. 'See Mikesell (1984, 1986), Parle and Hirlinger (1986), and Jackson (1986). 2See Alm and Beck (1988) and Andreoni (1989). 3For example, Fisher and Gocldeeris (1988) discuss the Michigan --ty participants, and Ahn and Beck (1989) analyze empirically the revenue impact of specific amnesty characteristics. "See, for example, Allingham and Sandmo (1972). 'See, for example, Dawes, et al., (1986) and Bagnoli and McKee (1988). 'Note that this means that the individual pays back taxes plus a fine equal to two times back taxes if caught cheating. 7 For example, see Friedland, Maital, and Rutenburg (1978) and Spicer and Becker (1980). 'In fact, there is some evidence that the use of loaded terms may not affect experimental tax compliance results, at least under some circumstances. Alm, McClelland, and Schulze [19891 compare the results of two treatments, one that uses loaded terms and one that uses neutral terms; in all other respects the treatments are identical. They find that the two treatments give identical results, which suggests that behavior may not be affected by the nature of the instructions when subjects are given full and complete information on the parameters relevant to their , . cnoices. 'The use of student subjects is nearly universal in experimental economics. Availability and cost play a role in this decision. The use of student subjects is also valid when one considers that properly designed experiments evaluate individual decisionmaking, and there is no reason to doubt that students have access to the same cognitive processes as individuals in the outside world. Those studies comparing student and "'tudent subject responses have generally found no significant difference. See Plott (1987) for further discussion and examples (airport landing slot allocations, antitrust cases, and allocation of resources within a committee structure). "Some additional sessions have been conducted in which the probability of detection and the penalty rate are set at lower levels before and after any enforce. ment change (the probability of audit is 0.02 before and 0.04 after; the penalty rate is 1 before and 2 after), and other parameters are unchanged from the ,essions reported here. The reduced enforcement lowthe average compliance rate. However, in all other ers respects (responses to tax amnesties, to increased enforeement, and so on) the results of these sessions am identical to the results of the sessions reported here. These sessions do not formi a complete set because they were conducted primarily to test the sensitivity of the design. "For all treatments the data are evaluated for ENDNOTES rounds 1 through 13 and for rounds 14 through 25. The Bowman-Shelton statistics for each treatment for ***An Appendix describing our experiments is available on request from the authors. Earlier ver- each set of rounds are: sions of this paper were presented at the joint Public Rounds 14-25 Session Rounds 1-13 Choice Society/Economic Science Association Meet0659 si 0.464 ings in March 1989 and at the National Tax Associ82 0.552 0821 ation Annual Conference on Taxation in October 1989. S3 0.875 1.592

If the government wants to increase penalties and audits in a manner that taxpayers perceive as fair, then it may be necessary to accompany these changes with an amnesty to provide a one-time grace period before the enforcement is increased. As is true of any applied work, these results should be viewed with some caution. Still, they should not be dismissed lightly No field data exist at present to examine * the long-run impact of an amnesty, and there is little chance that such data Will become available in the future. Laboratory methods offer perhaps the only opportunity to investigate in a controlled environment the behavioral responses to a tax amnesty. Of course, one might still ask whether experimental results can contribute to policy debates. There is an extensive-and growing-literature that argues convincingly that the answer is yes. As discussed by Plott (1987), to be of use in policy analysis the experimental setting must satisfy the condition of "parallelism." This does not mean that the experimental setting must mimic every nuance of the naturally occurring setting that is the object of investigation. Instead, the experimental setting must place the subjects in a decisionmaking environment that captures the essential properties of the field setting. In the experiments reported here, subjects face a tax, penalty, distribution, and amnesty process similar in basic structure to those actually faced by taxpayers in deciding how to behave before, during, and after an amnesty. It is possible to disagree over the magnitudes of various parameters in the design. It seems likely, however, for parallelism are metthathere.theTheconditions results from the experiments therefore provide needed insight into the behavior of taxpavers when faced with a compliance and amnesty decision.


AMNESTIES

No. 11 S4 S5 S6 S7

0.833 1.143 1.032 1.688

AND COMPLIANCE

2.417 2.231 0.621 1.137

The critical value of the statistic is 2.43, and the assumption of normality for all sessions is not rejected at the 10% level. "The Mann-Whitney tests yield the same conclusion. The compliance rates before the amnesty in 82 are greater than after the amnesty at the .01 level (zstatistic = 2.40). Similarly, the compliance rates for rounds 14 to 25 are higher in 81 than in S2 at the .01 level. "The t-statistic for Sl and S5 is 6.06, and is 1.64 for Sl and S6. The critical values are 1.66 and 2.33 at the 0.05 and 0.01 levels for a one-tailed test with 48 degrees of freedom. '4The t-statiatic for Sl and S5 is 5.34 and for Sl and S6 is 3.48, both of which are significant at the .001 level. This is confirmed by the Mann-Whitney test, which reports that compliance in Sl is higher than in S5 and S6 at the .01 level. '5A Mann-Whitney test indicates that compliance in S7 after the amnesty is lower than before at the .05 level (z-statistic = 2.07). 16A Mann-Whitney test for 82 indicates that the compliance rate before the amnesty is greater than that after the amnesty at the .01 level; for S4, the preamnesty compliance rate is less than the post-amnesty compliance rate at the .01 level 17 The Mann-Whitney test supports these findings. Compliance is higher in rounds 14 to 25 of S4 than in S3 at the .01 level (z-statistic = 2.80) "Individual data on back taxes paid in the atnnesties are available upon request. '@ENFORCEMENT equals 1 for S4 and 0 for all other sessions. EXPECTATION equals 1 for S2, S4, and S6 and 0 for S7. 'The coefficient estimates for the lagged amount of the public good in 81 to S7 (t-statisties are in parentheses) are, respectavely, .41 (5.72), 45 (3.96),.48 (7.64), .45 (7.43),.23 (2.39),.42 (5.39), and 39 (4 75). 2'lndividual data for all sessionr, are available upon request. 'See, for example, Witte and Woodbury (1985) and Dubin and Wilde (1988). 'ENFORCEMENT equals I for rounds 14 to 25 of S3 and S4 and 0 otherwise. ANNOUNCEMENT equals 1 for all rounds of 85 and S6 and 0 otherwise. AMNESTY equals 1 for rounds 14 to 25 of S2, S4, S6, and S7 and 0 otherwise. 2'Me promise of no future amnesties apparently has no effect on compliance. An additional variable PROMISE was defined (equal to 1 for rounds 14 to 25 of 87 and 0 otherwise), and included as an interaction term with AMNESTY. However, the coefficient on AMNESTY*PROMISE was never significant, and so this variable was omitted from analysis.

REFERENCES Allingham, "Income

Michael G. and Agnar Sandnio (1972). Tax Evasion: A Theoretical Analysis,"

37

Journal of Public Economics, 1 (4), 323-338. Alm, James and William Beek (1988). "Tax Amnesties and Tax Revenues," University of Colorado Working Paper. Alm, James and William Beck (1989). "Wiping the Slate Clean: Individual Response to State Tax Amnesties," University of Colorado Working Paper. Alm, James, Gary H. McClelland, and William D. Schulze (1989). "Why Do People Pay Taxes?" University of Colorado Working Paper. Andreoni, James (1989). "The Desirability of a Permanent Tax Amnesty," SSRI Workshop Series 8901, University of Wisconsin-Madison. Bagnoli, Mark and Michael McKee (1988). "Voluntary Provision of Public Goods Can Be EiTicientEmpirical Evidence," University of Michigan Working Paper. Conover, W. J. (1980) Practical Nonparanwtric Statistics, New York, NY: John Wiley & Sons, Inc. Dawes, R., J. M. Orbell, R. T. Simmons, and A. J. C. Van de Krae (1986). "Organizing Groups for Collective Action," American Political Science Review. Dubin, Jeffrey A. and Louis Wilde (1988). "An Empmcal Analysis of Federal Income Tax Auditing and Compliance," National Tax Journal, 41 (1), 61-74. Fisher, Ronald C. and John H. Goddeeris (1988). "Taxpayer Participation in Amnesties: The Individual Income Tax," Michigan State University Working Paper. Friedland, Nehemiah, Shlomo Maital, and Aryeh Rutenburg (1978). "A Simulation Study of Income Tax Evasion," Journal ofpublic Economics, 10, 107-116. Isaac, R. M., K. McCue, and Charles R. Plott (1985). "Public Goods Provision in an Experimental Environment," Journal ofpublic Economics, 26 (1), 5174. Jackson, Ira (1986), "Amnesty and Creative Tax Administration," National T= Journal, 38 (3), 317323. Mikesell, John L. (1986). "Amnesties for State Tax Evaders: The Nature of and Response to Recent Programs," National Tax Journal, 39 (4), 507-525. Newbold, P. (1988) Statistics for Business and Economics, Prentice-Hall, Englewood Cliffs. Parle, William M. and Mike W. Hirlinger (1986). "Evaluating the Use of Tax Amnesty by State Govemments," Public Administration Review, 246-255. Plott, Charles R. (1987). "Dimensions of Parallelism: Some Policy Applications of Experimental Methods," in Alvin E. Roth (ed.) Laboratory Experimentation in Economics: Six Points of View, New York, NY: Cambridge University Press. Samuelson, Paul A. (1954). "The Pure Theory of Public Expenditure," Review ofeconomics and Statistics, 36, 387-389. Skinner, Jonathan and Joel Slemrod (1985). "An Economic Perspective on Tax Evasion," National Tax Journal, 38 (3), 345-353. Spicer, Michael W. and Lee Becker (1980). "Fiscal inequity and Tax Evasion: An Experimental Approach," National Tax Journal, 33 (2), 171-175. Witte, Ann D., and Diane F. Woodbury (1985). "The Effect of Tax Laws and Tax Administration on Tax Compliance: The Case of the U.S. Individual in. come Tax," National Tax Journal, 38 (1), 1-14.