Tax Evasion and Entrepreneurship: The Effect of Income Reporting Policies on Evasion. An Experimental Approach

ABSTRACT: We use experimental economics methods to better understand personal income tax compliance behavior when a portion of an individual’s income is relatively difficult to detect by the tax authority. Self-employment income represents a type of income that could be difficult to identify, in part because there is no third party to report such income to the tax authority. In this experiment, subjects earn income and are told they must pay taxes on it. They choose what portion to report to the tax authority. They are told that a certain portion of their income can be detected with certainty while the remainder can only be detected with some known probability. They are also aware of the audit and the tax rates. Preliminary results indicate that overall levels of tax compliance do not respond significantly to earning larger portions of income that is not perfectly detectable. Results also indicate that tax compliance rates decline with lower audit rates and with higher tax rates