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If the IRS Is Watching You, You’ll Pay Up

What would be more likely to get you to report the whole truth and nothing but the truth on your tax returns? A notice that says "Don't cheat" or one that says "Don't be a cheater"?

As it turns out the personalized injunction works better than the more generalized abstract principle — though neither works as well as the plain, old-fashioned threat of an audit.

With April 15 looming in the not-so-distant future, that is just one of the lessons that has emerged from the recent explosion of research into tax cheating. Inspired by a new availability of data sets and technological tools, economists and social scientists are trying to figure out what will blunt the ever-present temptation to cheat on one's taxes.

The Internal Revenue Service headquarters in Washington.
Andrew Harrer | Bloomberg | Getty Images
The Internal Revenue Service headquarters in Washington.

Although categorized under the rather unglamorous heading of tax compliance, the studies are really about what motivates human behavior. Our brains are all subject to a stew of greed, shame and honesty, not to mention gut-level notions of fairness and calculated assessments of risk.

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According to the most recent estimates from the Internal Revenue Service, about 83 percent of the taxes that individuals and businesses owed in 2006 were paid upfront. The rest — stashed out of the government's reach, intentionally or not — amounted to a huge $450 billion in unpaid taxes.

The I.R.S. recouped about $65 billion of that through audits and other enforcement activities, but that still left another $385 billion in lost revenue — enough to eliminate a hefty chunk of the most recent budget deficit.

Figuring out low-cost ways to get more people to pay more of what they owe is animating the latest wave of research and spurring the tax collectors themselves to participate.

And what study after study reveals is that the tendency to cheat increases significantly when no one is checking. Just ask yourself whether you are as likely to report the $100 won at a poker game as you are your weekly paycheck.

Underreporting is estimated to be as low as 1 percent for wages that are reported by employers to the government and taxes that are automatically withheld from workers' paychecks. If there is only "some" third-party reporting, the evasion rates climbs to 11 percent. When there is no outside reporting, like the self-employed cafe owner or house painter, it can reach as high as 56 percent, according to I.R.S. estimates.

In some instances, cheating is even more rampant. A 2008 investigation by a Senate subcommittee disclosed that out of the 20,000 bank accounts held by American citizens and managed by the banking giant UBS in Switzerland, 95 percent were hidden from the I.R.S.

"We know when there's no third-party reporting, the tax evasion rate can be very, very big," said Gabriel Zucman, an economist at the University of California, Berkeley and the author of "The Hidden Wealth of Nations: The Scourge of Tax Havens." He has estimated that about 8 percent of the world's financial wealth is stashed in offshore accounts, resulting in a yearly global loss of $200 billion in lost income tax revenue.

Such fraud shifts the burden to honest taxpayers, Mr. Zucman said; collecting the money that is due would make it possible to lower the tax rate on everyone else.

There are costs from more burdensome reporting requirements and more intrusive enforcement, even for honest taxpayers.

But given the effectiveness of reporting, said David Weisbach, a law professor at the University of Chicago Law School, greater use of modern information technology, including reports from credit card companies, makes sense.

People who complain that such reporting intrudes on individual privacy are basically protecting cheats, he argued. "The fact that they find it out from a third party rather than you doesn't change your privacy, it just changes how much you can lie about it," Mr. Weisbach said. "If you want privacy, that means changing the system, not changing how you comply with it."

Appeals to conscience and civic duty or a reminder of the public good that taxes makes possible are not nearly as effective as the threat of detection and punishment in reducing evasion.

Poor enforcement encourages people to cheat. "If people think they're not going to get caught if they cheat, or they're just fed up because they can't get the help they need from us to file their taxes, the system will be put at risk, and voluntary compliance is likely to suffer," the I.R.S. commissioner John Koskinen told a conference of accountants last month.

"When you have fewer employees doing compliance work, you end up leaving tax revenue on the table," Mr. Koskinen added, explaining how budget cuts have damaged the agency and cost the government at least $20 billion over the last five years.

Americans acknowledge as much. While people surveyed overwhelmingly say they believe everyone has a responsibility to pay their fair share, a majority admit that it is fear of an audit or third-party reporting that ultimately spurs them to hand over the money.

Still, there is some striking evidence that the rich are different: They are more tempted to push back against the government. In a classic study, Joel Slemrod, a tax expert at the University of Michigan, found that the amount of reported income increased among low- and middle-income individuals after they were told their returns would be "closely examined." Higher-income individuals had the opposite reaction — their reported income went down.

The results, Mr. Slemrod suggested, may be explained by the resources available to the wealthy. Backed by an array of legal and accounting experts, the rich view the early warning of an audit as just an opening gambit by the I.R.S. "They talk to their accountant, and he says, 'Calm down, it's a negotiation,' " Mr. Slemrod said. And so they respond in turn with a lowball offer of payment.

Mr. Slemrod said that what distinguishes the latest wave of research are the field experiments, a version of studying animals in the wild instead of in the laboratory. For example, researchers in the United States and elsewhere have sent different taxpayers different notices, comparing a warning that they have a 50-50 shot of being audited with one that says an audit is a certainty.

It turns out that just receiving any kind of alert from tax officials — a subtle reminder that they know about you, yes, you — can spur an uptick in payment.

And while moral appeals are often not very effective in getting people to reveal hidden income, there is some evidence they may work better when it comes to collecting a tax debt.

A study conducted in conjunction with the British tax collection agency found a significantly different response to a letter reminding people that nine out of 10 people pay their taxes on time with a second one that not only repeated the message but also warned: "You are currently in the very small minority of people who have not paid us yet."

Specifically pointing out that individuals were out of step with their fellow citizens prompted a greater proportion of people to pay, the study found.

Other types of nudges that some behavioral economists have championed have also registered some improved reporting — even if not as much as a threatened audit.

An advertising campaign introduced by the British government in 2012 inspired an additional 8,300 taxpayers to register unreported income, bringing in 19 million more pounds. The campaign included giant billboards featuring a pair of eyes peering through a torn sheet of paper, with the slogan: "We're closing in on undeclared income."

Think of it as a nonviolent version of Liam Neeson's threat in the film "Taken." We will look for you. We will find you. And we will accept credit and debit cards.