Behavioural economics and the risks of tax administration

Abstract

Tax Administration is a risky business. When taxes are not well administered, tax morale may be undermined and unnecessary administrative and compliance costs incurred. Mainstream economics and the self-interested rational choice model provide a powerful contribution to understanding the effects of taxation but that analysis has not always been enough to avoid serious and expensive difficulties. Behavioural economics has been making an increasing contribution to understanding how tax administration may be improved. Some of the assumptions of mainstream economics have been subject to close scrutiny and DellaVigna (2009) summarized deviations from the standard model as non-standard preferences, non-standard beliefs and non-standard decision-making. In recent years considerable analysis and evidence have been presented on the importance of aspects such as fairness in taxation, the endowment effect, framing of decisions, limited attention, loss aversion and mental accounting and their impact on the operation of a tax system. A risk management approach to tax administration has been developed by the European Commission, the OECD and others. One area that has received less attention than may be appropriate is the performance of tax agencies themselves. This paper therefore outlines the contribution behavioural economics can make to existing approaches in reducing the risks of tax administration and extends it to the performance of tax authorities themselves.