Unwilling or Unable to Cheat? Evidence From a Tax Audit Experiment in Denmark

TLDR

The study analyzes a tax enforcement field experiment in Denmark. The experiment sampled over 40,000 Danish tax filers, randomly auditing half and sending threat‑of‑audit letters to all in the following year. The results show that tax evasion is negligible for third‑party reported income but significant for self‑reported income, that higher marginal rates slightly raise self‑reported evasion, and that prior audits and threat letters reduce self‑reported income but have no effect on third‑party reporting.

Abstract

This paper analyzes a tax enforcement field experiment in Denmark. In the base year, a stratified and representative sample of over 40,000 individual income tax filers was selected for the experiment. Half of the tax filers were randomly selected to be thoroughly audited, while the rest were deliberately not audited. The following year, threat-of-audit letters were randomly assigned and sent to tax filers in both groups. We present three main empirical findings. First, using baseline audit data, we find that the tax evasion rate is close to zero for income subject to third-party reporting, but substantial for self-reported income. Since most income is subject to third-party reporting, the overall evasion rate is modest. Second, using quasi-experimental variation created by large kinks in the income tax schedule, we find that marginal tax rates have a positive impact on tax evasion for self-reported income, but that this effect is small in comparison to legal avoidance and behavioral responses. Third, using the randomization of enforcement, we find that prior audits and threat-of-audit letters have significant effects on self-reported income, but no effect on third-party reported income. All these empirical results can be explained by extending the standard model of (rational) tax evasion to allow for the key distinction between self-reported and third-party reported income.