The ‘scarecrow’ method of getting people to pay taxes actually works

Maybe taxpayers just aren’t scared enough.

Companies are more likely to comply with tax laws when they are reminded how likely they are to be audited, according to a new working paper from researchers at la Universidad de la Republica in Uruguay and at the Anderson School of Management at University of California, Los Angeles. The study was distributed by the National Bureau of Economic Research, a Cambridge, Mass.-based research group.

The researchers collaborated with Uruguay’s Internal Revenue Service and sent letters to more than 20,000 companies in that country that collectively pay more than $200 million in taxes every year.

They designed two types of letters: One that contained brief and generic information about taxes, and another that also included some statistics about the likelihood of being audited and how much the corporation would have to pay as a penalty if they do not pay taxes properly, based on Uruguayan tax administration data.

The researchers wanted to test a previous study from 1972, which asserted that firms decide whether to evade taxes by calculating whether it would cost them more to pay the taxes or more to pay the penalty if they were audited.

The more recent study showed that being presented with information about the likelihood of audits appeared to sway firms’ behavior even more than researchers expected. They increased their tax payments, even if the information presented to them suggested their chances of being audited were somewhat unlikely.

The conclusion: Sending letters about audits creates a similar effect to putting scarecrows in a field to frighten off birds, the researchers said.

“Our favorite interpretation of these findings is that the messages about audits affects tax evasion decisions primarily through creating a sense of fear, rather than by making the taxpayers revise their beliefs about audits,” they wrote.

The researchers were studying companies, but many individual taxpayers still make mistakes when making their payments, or even refuse to pay taxes as a form of political protest.

Some 60% of federally licensed tax professionals said working full or part-time as independent contractors is among the most common reasons Americans miscalculate how much they owe in taxes, according to a survey of more than 2,300 tax professionals released Monday from the National Association of Enrolled Agents, a Washington, D.C.-based nonprofit organization that provides services to tax professionals, including educational and networking opportunities.

The mismanagement or improper handling of a 1099-B form, which summarizes proceeds of stock transactions or barter income, or a Schedule K-1, the report of income from a partnership, corporation or trust, is the second most common reason (60%) why they made an error on their taxes.

And nearly 40% said receiving a notice saying they have made a mistake on their taxes is that they rush to file early because they expect a refund, but they don’t have all the necessary tax documents included.

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