Fiscal blackmail: Lessons from behavioural economics can boost tax compliance

Fiscal blackmail: Lessons from behavioural economics can boost tax compliance

May 24th 2014 | From the print edition

PEOPLE go to great lengths to avoid paying tax. One popular trick in the Middle Ages was to become a monk; these days, shell companies in the Caribbean are a more common retreat. The gap between what is owed and what is paid is nearly $400 billion a year in America, and about £40 billion ($70 billion) in Britain. To keep the shortfall in check, governments design taxes to be tough to weasel out of. The value-added tax, for instance, allows firms to deduct tax paid on inputs from their sales-tax bill, in effect encouraging them to police their suppliers. Then there are the sticks: audits and penalties. Promising new research in behavioural economics could give governments another tool for boosting payment: the psychological nudge.

Economists have long understood that psychology matters in tax systems. Studies repeatedly find that tax gaps are much smaller than one would predict given the rarity of audits and the benefits of underpayment. Many taxpayers are motivated by more than just pecuniary concerns. Feelings of patriotism and civic duty ease the pain of paying tax (or make dodging less attractive). Guilt, or the perceived moral cost of violating social norms, also seems to enter the equation. It stands to reason that governments that exploit such emotions would save bundles of money in enforcement. They are already using such tactics to nudge people towards other desirable goals, such as saving energy or planning for retirement. Yet economists are only just beginning to test whether a similar approach could bring in more tax.

A recent working paper from America’s National Bureau of Economics Research documents experiments conducted by economists from Imperial College in London and the University of Chicago, with the British government. Whereas most Britons have their income taxes automatically deducted from their pay, a few with particularly high or complicated incomes file annual returns. Some of those who report that they owe tax are nonetheless slow to pay. Since they have already admitted their debt to the taxman, they are probably not trying to evade it. But the government must go through a time-consuming and expensive collection process to get what is owed.

That is where the economists come in. The authors conducted an experiment involving 100,000 taxpayers with overdue bills. They divided the sample into groups: one was sent a boilerplate request for payment; the others received letters with additional sentences designed to tug at the recipients’ heart- and purse-strings. One of the manipulative additions told the recipient what share of Britons pay their tax on time (about 90%). Another not only mentioned the share that pay on time but also pointed out that the delinquent was in the minority; a third noted that tax was vital for funding services like health care and roads.

All of the additions raised payment rates relative to the standard letter. Simply informing recipients of the share that pay on time or describing the public goods taxes fund boosted payment only modestly, by 1.3-2.1%. But the message which also underlined that the recipient was in the minority raised payments by 5.1%.

The authors reckon their insertions raised the perceived moral cost of failing to pay, which is enough to reform some delinquents. They also calculate that using the most effective wording in all the letters in the sample would have boosted the tax take, relative to the normal letter, by as much as £15.4m—all for the cost of the ink needed to print an additional sentence.

American and British experiments with taxpayer “receipts”, which explain how tax is spent, play on other emotions. The receipt is designed to mollify taxpayers who see little connection between what they pay and the services they receive. The less taxpayers feel they are getting for their money, the more likely they are to avoid paying. Research into donations to charity has reached a similar conclusion: donors are more generous when told more about how their gifts are used. Yet this strategy has its risks: if a big share of taxpayers discovers that the government’s priorities are more out of step with their preferences than they had previously believed, collections may fall.

No taxation without manipulation

In another new paper researchers investigate whether these receipts work as intended. They also add a twist, testing whether those who might be less likely to pay on learning how their money is spent can nonetheless be cajoled to comply if given the chance to air their views. After all, they note, Switzerland’s direct democracy is associated with higher “tax morale”.

In one experiment, the authors paid undergraduates to do some research, but asked them to return a share of the payment as a “lab tax”. Some students were given the option of suggesting how the tax should be spent. The chance to state a preference raised compliance by 16%.

In a second test the authors surveyed people doing freelance work via an online platform. The freelancers were asked about their attitude to taxes. Some were handed a tax receipt, some were given the option to state spending preferences, some got both and some neither. Respondents were then asked whether, given the option, they would take advantage of a tax loophole for which they might not really be eligible. Those given only the receipt were more likely to exploit the loophole than those given no information at all. But allowing workers to suggest how their taxes should be used cut take-up of the loophole by 15%.

The authors reckon that giving taxpayers the ability to state their views could provide useful information while raising revenues. Until, that is, observant taxpayers begin demanding cuts to spending on behavioural economics.


Eliciting Taxpayer Preferences Increases Tax Compliance“, by Cait Lamberton, Jan-Emmanuel De Neve, Michael I. Norton. Harvard Business School Working Paper 14-106, April 2014

The Behavioralist as Tax Collector: Using Natural Field Experiments to Enhance Tax Compliance“, by Michael Hallsworth, John A. List, Robert D. Metcalfe, Ivo Vlaev. NBER Working Paper 2007


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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