Tax Compliance and Norm Formation Under High-Penalty Regimes

Abstract:     
Skepticism about the potential of moral appeals relating to tax compliance — for example, as applied to large groups of individual taxpayers outside a wartime context — has resulted in the absence of a theory about how government communication can further tax compliance. This Article fills that gap. It provides a theory of tax compliance and norm formation under high-penalty regimes from the starting point of a noncompliance norm.

The theory explains the roles of, and mutually reinforcing relationships between, the compliance mechanisms of deterrence, separation, and reputation signaling. The success of these mechanisms depends on the presence of (i) taxpayer perception of penalty imposition, (ii) taxpayer perception of detection efficacy, and (iii) an absence of close substitutes. Either government enforcement or a reputation market can provide penalty imposition and detection efficacy. This Article offers the U.S. requirement of self-reporting of offshore bank account information as an example of a potentially effective high-penalty regime founded on aggressive and creative government enforcement efforts.

The theory also defines an appropriate role for expressive law in advancing tax compliance. This role has relevance, at least, when resources have been committed and government enforcement is not practical. The theory suggests that using law to define good-reputation indicators has particular promise when applied to reputation-sensitive taxpayers such as large intermediaries. This Article identifies four expressive law tax compliance tactics: reputation referencing, salience, management targeting, and incrementalism. It illustrates the expressive law portion of the theory with the example of FATCA, a law passed in 2010 that will require non-U.S. banks to identify U.S. account holders or face withholding on certain U.S. investment returns.

Number of Pages in PDF File: 62

Keywords: tax compliance, high penalty, norm formation, expressive law, offshore account, FBAR, FATCA

JEL Classification: K34, K23

Accepted Paper Series