Research undermines the notion that companies coldly calculate tax avoidance
The prevailing theory of business tax evasion frames it as a rational decision: Companies weigh the penalties they'll pay if caught against the money they'll keep if they aren't. It would follow, then, that threatening an audit wouldn't necessarily curb cheating, since it's possible to assess an audit threat rationally and still decide cheating is worth the risk.
In the U.S., for instance, the Internal Revenue Service helpfully publishes its audit activity and how much the efforts recover. Roughly 1 percent of corporate returns were audited in 2015. After the audits, the IRS sought, on average, an additional $28,601 for each return audited via correspondence and, on average, an additional $761,033 for audits done in person. The IRS's detailed data is almost an invitation to risk-reward calculation.
But new research suggests that audit threats are actually effective because, simply put, they scare people. At least in Uruguay.
In an NBER working paper, Marcelo Bérgolo, Rodrigo Ceni and Matias Giaccobasso of IECON-UDELAR, Guillermo Cruces of CEDLAS-UNLP and UCLA Anderson's Ricardo Perez-Truglia show what happens when that theoretical model of tax evasion is tested in the real world. Their results indicate that, once faced with the possibility of an audit, no matter the probability or penalty, firms tend to pay more in taxes going forward.
Tax compliance varies by country, reflecting economic, bureaucratic and cultural factors. The researchers chose Uruguay largely because it's an egalitarian, middle-income, economically stable country whose levels of tax regulation and evasion are on par with more developed nations. With a population of 3.4 million and strong industries dominated by agricultural exports, it's a good microcosm for business elsewhere. It's also important to note the Uruguayan tax agency was willing to collaborate and provide access to taxpayers.