Tax Audits as Scarecrows. Evidence from a Large-Scale Field Experiment

According to the workhorse model of Allingham and Sandmo (1972), firms evade taxes by optimally trading-off between the lower tax burden and the expected penalties from audits. However, there is still no consensus about... [ view full abstract ]

According to the workhorse model of Allingham and Sandmo (1972), firms evade taxes by optimally trading-off between the lower tax burden and the expected penalties from audits. However, there is still no consensus about whether firms react to audits and whether they react in a rational way. We conducted a large-scale field experiment with over 20,000 Uruguayan firms that collectively pay over $200 million dollars in taxes per year. We provided firms with exogenous but non-deceptive signals about the probability of being audited and the penalty rates for tax evasion. We measure the effect of this information on their subsequent perceptions about audits, measured with survey data, as well as on the actual taxes paid. We provide evidence that firm’s reaction to audits is subject to substantial optimization and information frictions.