THE EFFECTS OF PUBLIC TRANSFERS AND TAX RATE CHANGES ON REPORTED INCOME: EXPERIMENTAL EVIDENCE (EQUITY, TAX EVASION)

This study reports the results of two experiments conducted to explain the effects of public transfers and tax rate increases on how much income individual taxpayers choose to report to the government. "Public Transfers" refer to the goods and services that taxpayers receive from the government. The effects on reported income of the provision of the public transfer and tax rate changes are currently important issues in tax research. However, current analytical models of taxpayers' reporting decisions fail to describe the corresponding empirical evidence adequately. Instead, there exists a conflict between the economic predictions and empirical findings, particularly regarding the effect of tax rate changes on reported income. Results from compliance surveys suggest that equity constructs may help to reconcile this conflict.; This paper develops an economic model that incorporates public transfers in the taxpayer's utility function. The model provides predictions concerning the effects of public transfers and tax rate changes on how much income an individual taxpayer will report. Corresponding hypotheses derived from the economic model and equity theory are then tested in an experimental setting that requires subjects to act as taxpayers who make tax reporting decisions.; Results of this study indicate that economic incentives and exchange equity interact to determine an individual taxpayer's reporting behavior. In particular, when perceived exchange equity is held constant, the effect of a tax rate increase on reported income is positive, as predicted by economic models of taxpayers' reporting decisions. However, when a tax rate increase reduces perceived exchange equity, the economic prediction of an increase in reported income is not observed. These findings help to reconcile the existing conflict between the economic models and previous empirical evidence, and thereby improve our understanding of tax compliance behavior.