Extrinsic and Intrinsic Motivations for Tax Compliance: Evidence from a Field Experiment in Germany

Extrinsic and Intrinsic Motivations for Tax Compliance: Evidence from a Field Experiment in Germany Nadja Dwenger (MPI) Henrik Kleven (LSE) Imran Rasul (UCL) Johannes Rincke (Erlangen-Nuremberg) October 2014

A Tax Compliance Puzzle? Gap between theory and evidence: Theory predicts low compliance under low audit probabilities or penalties (Becker-Allingham-Sandmo) Evidence shows high compliance in modern tax systems despite low audit probabilities and penalties Closing the gap: Third-party information creates large detection probabilities Misperception of enforcement parameters Intrinsic or social motivations

Extrinsic and Intrinsic Motivations Extrinsic motivation (pecuniary): Deterrence and tax policy Intrinsic motivation (non-pecuniary): Duty,guilt,shame,socialnorms,reciprocity,etc. Studying intrinsic motives is difficult: measurement, variation We consider a setting in which we can identify extrinsically and intrinsically motivated individuals We vary deterrence and rewards/recognition in a field experiment

Local Church Tax in Germany: Key features Feature 1: tax and charity Legal obligation to pay for church members Overpayments are encouraged and represent donations Feature2: truetaxbaseisobservable True tax base for church = reported taxable income to government Distinguish evaders, compliers & donors Feature 3: zero deterrence in the baseline Church never cross-checks reports against income tax returns Baseline compliance = intrinsic motivation

Local Church Tax in Germany: Identifying Motivation Baseline behavior (p = 0) reveals motivation: Baseline compliers & donors: intrinsically motivated Baseline evaders: extrinsically motivated Compliance type is very persistent prior to experiment: We define types based simply on one pre-treatment year Each type could be subject to misperception (p 0): Estimate misperception via (randomized) communication of =0 Separate misperception from motivation

Outline 1. Conceptual framework: warm-glow model of tax compliance 2. Context, design and data 3. Empirical findings (a) Baseline compliance under zero deterrence: Amount of intrinsic motivation; duty to comply (b) Randomized field experiment: Simplification; misperception; deterrence; rewards 4. Conclusion

Local Church Tax in Germany Legal tax obligation for church members above 18 years of age Membership by baptism; possible to quit church 60% of the population are members Two tiers of church taxes: federal state, church district Our focus: Local church tax for Protestant church in a large metro area of Bavaria Legal tax obligation determined by a progressive schedule Payments above legal tax obligation defined as donations Concern with external validity: stakes are small

Local Church Tax in Germany: Tax Schedule

Experimental Design Manipulations of the official tax notification from the church tax authority Randomly assignment to treatment letters: Tax simplification Zero deterrence (misperception) Positive Deterrence (audit probabilities) Compliance rewards (social and monetary rewards) Randomization successful across all letter groups All treatments were truthfully implemented

Data Linked administrative panel data 2008-2012: Church District tax records State personal income tax records About 40,000 individuals per year with information on actual church taxes paid, true church taxes owed, and personal characteristics Individual records of tax compliance for up to 4 years pre-treatment

Compliance Under Zero Deterrence [Distributions of Payment Made and Payment Owed] (Control Group)

Finding 1: Intrinsic Motivation is Substantial (or Not) Under zero deterrence, predicted compliance is zero absent intrinsic motivation But a significant fraction of individuals comply: 20% of individuals make payment true taxes owed 80% of individuals make payment true taxes owed (and most of them pay zero) Implications for the compliance puzzle debate: The Becker-Allingham-Sandmo model is 20% wrong, 80% right

Bunching at Exact Compliance under Zero Deterrence [Distribution of payment made payment owed] (Control Group)

Finding 2: Bunching at Exact Compliance Sharp bunching at exact compliance under zero deterrence: No pecuniary discontinuity at exact compliance under zero deterrence Discontinuity in intrinsic motivation at exact compliance Two possible explanations (labels): 1. Duty to comply with the letter of the law 2. Attention/focal point effects (We provide a test suggesting against the latter)

Tax Simplification [Heterogeneity Across Compliance Types] (Simplification vs Control) Full Sample Baseline Evaders Baseline Donors (Extrinsically Motivated) (Intrinsically Motivated) Probability of Evading Evasion Rate Probability of Evading Evasion Rate Probability of Donating Increased Donation Rate Tax Simplification -2.45** -3.17*** -2.66*** -3.36*** -4.04-30.37 (0.971) (0.910) (0.747) (0.732) (6.97) (27.88) Outcome in comparison group (control group) 79.29% 76.35% 94.98% 92.35% 62.34% 9.09% Number of Observations 5076 5076 4007 4007 476 476

Tax Simplification [Distributional Effects on Baseline Evaders] (Simplification vs Control)

Correcting Misperception [Heterogeneity Across Compliance Types] (Zero Audit Probability vs Simplification) Full Sample Baseline Evaders Baseline Donors (Extrinsically Motivated) (Intrinsically Motivated) Probability of Evading Evasion Rate Probability of Evading Evasion Rate Probability of Donating Increased Donation Rate Correcting Misperception 0.942 0.957 1.53** 1.41* 1.52 50.61 (0.889) (0.857) (0.715) (0.720) (5.78) (37.38) Outcome in comparison group (simplification group) 77.30% 73.37% 92.35% 88.69% 61.63% 5.71% Number of Observations 7641 7641 6049 6049 723 723

Correcting Misperception [Distributional Effects on Baseline Evaders] (Zero Audit Probability vs Simplification)

Finding 3: Simplification Matters, Misperception Less So Tax simplification: Baseline evaders: strong positive effect on compliance Baseline donors: no significant effect Correcting misperception of audit probability: Baseline evaders: weak negative effect on compliance Baseline donors: no significant effect

Positive Audit Probability [Heterogeneity Across Compliance Types] (Positive Audit Probability vs Zero Audit Probability) Full Sample Baseline Evaders Baseline Donors (Extrinsically Motivated) (Intrinsically Motivated) Probability of Evading Evasion Rate Probability of Evading Evasion Rate Probability of Donating Increased Donation Rate Deterrence -3.13*** -2.80*** -3.12*** -2.81*** 7.07* 25.59 (0.660) (0.627) (0.536) (0.534) (4.22) (22.20) Outcome in comparison group (zero audit prob group) 78.04% 74.52% 93.80% 90.43% 61.72% 8.16% Number of Observations 12692 12692 9979 9979 1261 1261

Positive Audit Probability [Distributional Effects on Baseline Evaders] (Positive Audit Probability vs Zero Audit Probability)

Perceived Penalty? Audit results suggest a perceived penalty of being caught evading But we can provide direct evidence using a bunching approach: Asymmetric treatment of evaders (expected penalty = )and donors (zero penalty) Penalty kink under 0 iff perceived penalty is positive There is already bunching under =0( duty-to-comply ), so we consider Change in bunching when moving from =0to 0

Perceived Penalty [Change in Bunching at Exact Compliance] (Positive Audit Probability vs Simplification)

Finding 4: Deterrence Works on the Extrinsically Motivated, Not on the Intrinsically Motivated Baseline evaders: compliance increases with deterrence Significant increases for uniform audit probabilities of 10%, 20%, 50% Stronger effects for notched audit probability Significant responses to perceived penalty Baseline donors: weak effect of deterrence No effect on donation amount, weak effect on probability of donating Hence there is no extrinsic-intrinsic crowd-out

Compliance Rewards [Heterogeneity Across Compliance Types] (Social/Monetary Rewards vs Simplification) Full Sample Baseline Evaders (Extrinsically Motivated) Baseline Donors (Intrinsically Motivated) Probability of Evading Evasion Rate Probability of Evading Evasion Rate Probability of Donating Increased Donation Rate Compliance Rewards 0.259 0.447 1.27* 1.20* 2.02 83.24** (0.821) (0.789) (0.664) (0.666) (4.95) (32.80) Outcome in comparison group (simplification group) 77.30% 73.37% 92.35% 88.69% 61.63% 5.71% Number of Observations 12632 12632 9909 9909 1247 1247

Compliance Rewards [Distributional Effects on Baseline Evaders] (Social/Monetary Rewards vs Simplification)

Finding 5: Recognition Works on the Intrinsically Motivated, Not on the Extrinsically Motivated Compliance rewards create opposite effects on the two types: Baseline donors increase donations Baseline evaders further reduce compliance Average effect is strongly attenuated Interpretation: Rewarding compliers (rather than punishing evaders) highlights voluntary contribution aspect and downplays mandatory tax aspect

Conclusions Some of the first evidence on intrinsically motivated tax compliance Direct evidence on intrinsic motivation from a zero deterrence baseline: Becker-Allingham-Sandmo model is 20% wrong, 80% right Study interaction between individual motivation and policy First integrated treatment of tax compliance and charitable giving Imperfectly enforced tax systems have an element of voluntary giving External validity issues are addressed in the paper: Smallness of tax; zero enforcement signal; donation substitution