Who is audited? Experimental study on rule-based tax auditing schemes

Abstract

In this study, we employ a game-theoretic framework to formulate and analyze a number of tax audit schemes. We then test the theoretical predictions in a laboratory experiment. We compare audit schemes based on three audit rules: the random rule, cut-off rule, and lowest income reporter audited rule. While the cut-off rule is known to be optimal in theory, it has not thus far been examined in a controlled laboratory experimental setting. Contrary to the theory, the lowest income reporter audited rule yielded higher compliance behavior than the optimal cut-off rule in the experiment, even after controlling for social norms regarding tax payment perceived by the subjects. This empirical finding is practically important because the tax authorities in most countries assign higher priority to enhancing tax compliance.