Taxpayer Disclosure and Penalty Laws

University of Illinois Working Paper No. 99-0124

34 Pages Posted: 22 Nov 1999  

Jon S. Davis

University of Illinois at Urbana-Champaign - Department of Accountancy

Paul J. Beck

University of Illinois at Urbana-Champaign - Department of Accountancy

Woon-Oh Jung

Seoul National University

Multiple version iconThere are 2 versions of this paper

Date Written: October 21, 1999

Abstract

The tax auditing context is illustrative of a more general set of situations in which regulators attempt to extract information from entities over whom they have oversight (Border and Sobel 1987). Hence evaluating the impact of various features of the tax setting can provide important insights into a variety of regulatory environments. One unique aspect of the tax law in the United States that may have implications for other regulatory contexts is the exemption from penalties afforded to taxpayers who disclose reporting positions lacking authoritative support (where the application of tax law is uncertain). This unique provision would seemingly have an adverse impact on compliance if taxpayers respond strategically and take more aggressive reporting positions. Offsetting this effect, disclosure of aggressive positions could make audits more efficient. An evaluation of the impact of the disclosure exemption may provide insights into other regulatory situations where communication is at the discretion of the regulated entity and communication requirements are ambiguous.

This paper reports the result of a game theoretic investigation of the consequences of the tax disclosure exemption. In our analysis, we find that: (1) taxpayers sort themselves out into (at most) three groups based on their type and thus partially signal information through their disclosure decisions, (2) the tax agency?s expected revenue collections (net of audit costs) decline when taxpayers are allowed to exempt themselves from penalties by making disclosures, and (3) the impact of disclosure regulations depends on the taxpayer?s type. Of particular interest is the fact that taxpayers with a low likelihood of successfully defending a questionable deduction decrease their expected payments although they don?t actually disclose in equilibrium. Finally, we find that the amount of resources absorbed by the tax collection process can either increase or decrease when taxpayers have an opportunity to obtain a disclosure exemption, depending on the amount of tax at issue.

JEL Classification: H26, C72, D82

Suggested Citation

Davis, Jon S. and Beck, Paul J. and Jung, Woon-Oh, Taxpayer Disclosure and Penalty Laws (October 21, 1999). University of Illinois Working Paper No. 99-0124. Available at SSRN: https://ssrn.com/abstract=194172 or http://dx.doi.org/10.2139/ssrn.194172

Jon S. Davis (Contact Author)

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
2173000489 (Phone)

HOME PAGE: http://aboutme.com/jondavis

Paul J. Beck

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

1206 South Sixth Street
293 Commerce West
Champaign, IL 61820
United States
217-333-4563 (Phone)
217-244-3118 (Fax)

Woon-Oh Jung

Seoul National University ( email )

Seoul, 151-742
Korea, Republic of (South Korea)

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