Audits, Audit Effectiveness, and Post-audit Tax Compliance

Abstract

It is well established in theoretical and empirical research that more audits lead to more post-audit tax compliance. However, there is growing recognition that the deterrent effects of audits are more complicated than first appears, in part because audits do not always detect evasion. This study uses a laboratory experiment to investigate the effect of tax audits on post-audit tax compliance. An important feature of our experimental design is the addition of audit “effectiveness” to our audit mechanism, where effectiveness is defined as the share of undeclared income that the tax agency detects in an audit. This addition allows us to examine the effects of audit effectiveness on post-audit compliance. We also study whether the effect of audits depends on a taxpayer’s reporting behavior prior to an audit. Contrary to standard theoretical predictions, we find that tax audits have differential effects on post-audit compliance and that the effectiveness of audits determines these responses; that is, while effective audits increase post-audit tax compliance, ineffective audits have the opposite effect. We also find that relatively compliant taxpayers exhibit the strongest behavioral response to audits. Our findings suggest that the specific deterrent effect of tax audits is more ambiguous than much previous analysis suggests, with these effects dependent on the effectiveness of the audit process and on the taxpayer’s prior reporting behavior.

Keywords: Tax compliance; Audit effectiveness; Specific deterrence; General deterrence; Laboratory experiments

JEL Classification: C9; H26; H83