First Things First: Using Anchoring Bias to Examine the Effect of Penalty Severity and Social Norms on Compliance

Abstract

Research shows that penalties for tax fraud can increase observers’ compliance (i.e., following tax related rules). However, we do not have a clear understanding of how penalties at various levels of severity interact with national social norms to influence compliance differently. In order to establish what level of penalty severity encourages compliance (i.e., an appropriate penalty that is neither too lenient nor too harsh), I conduct a two-part survey. Based on these findings, I experimentally examine whether taxpayers’ compliance is affected by two factors: (1) Severity of noncompliance penalty and (2) National social norms of tax compliance. Results indicate that compliance is higher when noncompliance penalties are appropriate versus lenient. I also find that the benefit of appropriate penalties is suppressed when taxpayers anchor on information about the national social norms of tax compliance than when they do not have such information. With these results, I conclude that governments can increase compliance by imposing appropriately severe noncompliance penalties and promoting policies that improve compliance norms.

Keywords: anchoring bias, penalty severity, social norms, deterrence theory, compliance

JEL Classification: M4