Underreporting of income is a costly problem for the government and for those people who do pay their taxes, due to the necessity of higher tax burdens to sustain a given amount of revenue. An extensive research report published by the IRS this year estimates that in the United States in 2006 the “tax gap” between paid taxes and legally owed taxes was $450 billion, which means 16.9 percent of total tax liabilities were evaded that year (Black et al., 2012). The IRS recovered $65 billion from late payments and audits, but that still left 14.5 percent noncompliance. Breaking the tax gap down into finer categories, the IRS finds that the vast majority (84 percent) comes from underreporting of income, most of that (62.5 percent) comes from individual income taxes, and most of that (52 percent) is small business proprietor’s income. This totals to 27 percent of noncompliance due to underreporting of individual proprietor income. It is estimated that 57 percent of business income is not reported (Black et al., 2012). Wages make up a small fraction of underreporting, mostly due to the fact that firms must report employee income directly to the IRS, and withholding is common, so a relatively disinterested third party makes the decision of how much income is reported (Slemrod, 2008). Slemrod emphasizes the importance of enforcement in compliance behavior, citing the fact that income subject to withholding and substantial information reporting (wages) has a 1 percent noncompliance rate, compared to 56 percent noncompliance for income with little or no information reporting requirements. Given the difficulty of identifying cheaters and the cost of increasing the rate of auditing, a better understanding of the determinants of noncompliance is needed 1 to reduce the magnitude of tax cheating. To address a part of the tax evasion quandary, Kalambokidis et al. (2012) conducted a laboratory experiment1 which was designed to examine the feasibility of using the choice between a high-burden,2 low-transparency and a low-burden, high-transparency tax regime, as a mechanism to separate out those who have higher and lower propensities to cheat when reporting their income. The results are the subject of this paper.
