Tax compliance and social acclaim

There is significant potential for improving revenue collection through social recognition programmes

Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

High rates of economic growth, in-migration and urbanization have stressed the ageing infrastructure of Bangladesh. Firm production is regularly disrupted by power outages, and Dhaka, the epicentre of economic activity, is rated as one of the most unlivable cities in the world. Tax revenues are required to address the acute infrastructure challenges necessary to support economic growth, but Bangladesh has one of the lowest tax to gross domestic product (GDP) ratios in the world.

Audits and fines as methods to increase tax revenue are difficult to implement and enforce. Exploiting firms’ interest in receiving social recognition may be an alternative way to increase value-added tax (VAT) revenues in Bangladesh. Research that I have conducted with Raj Chetty and Monica Singhal from Harvard suggests exposing information about firms to their peers can increase tax compliance and payment.

We partnered with the Bangladeshi National Board of Revenue (NBR) to conduct a multi-arm randomized control trial to rigorously evaluate the impacts of social incentives and peer recognition on voluntary tax compliance for Bangladeshi firms. The randomly assigned interventions in our experiment designated geographic clusters of firms to receive various types of information and recognition treatments. One of the treatments we tested involved delivering letters to inform firms that their tax compliance behaviour would be shared with other firms in their cluster in a subsequent letter. The theory was that this intervention may spur voluntary tax compliance by allowing firms to get recognition from their neighbours and peers.

As expected, firms’ reactions to this intervention varied by the characteristics of the area before the intervention began, and the payment norms prevalent there. In low compliance areas, where less than 15% of firms in a cluster paid any VAT the previous year (in 2012), the peer recognition treatment had no significant effect on tax payment rates.

However, in areas where at least 15% of firms had paid the VAT in 2012, firms who received the peer recognition treatment were 3.4 percentage points more likely to make a payment in the post-intervention period (compared to firms in observationally equivalent clusters that were randomly assigned to a control group that received a generic letter which did not mention any possibility of exposure of firm payment information to peers).

This effect was largely driven by the specific firms who had neglected to pay the previous year. This group was six percentage points more likely to make a payment during the post-intervention period relative to the control group. In summary, firms who had not paid the previous year, but whose neighbours were paying, are the ones most likely to respond to the peer recognition letters.

These firms were not only more likely to pay, but they also paid more relative to the control group. Firms who received peer information paid 17% more on average than firms in who did not receive this information during our three month post-intervention period. Since these extra payments are generated in the relatively high-compliance areas that account for the majority of all VAT revenue, this 17% increase represents a quantitatively meaningful increase in total revenues. The estimated increase in revenue from the small sample of firms in our study area alone is 870,000 Bangladeshi taka ($11,441) during the short duration of the experiment. The cost of printing and hand-delivering the letters containing this information are quite low, resulting in a benefit-cost ratio of about five to one.

Our research reveals a clear behavioural response to peer information, but we must note that the effects may be a combination of increased payments, or treated firms putting in extra effort to ensure that their payments are recorded. While improved record-keeping is valuable for the NBR, generating new revenues is the bigger and more important prize. Regardless, our findings clearly demonstrate that firms pay attention to peer information letters and react in ways predicted by simple economic theory.

Firms who deviate from the norm of at least some tax payments in their clusters react strongly to the peer information treatment since these firms are at the greatest risk of revealing negative information to their peers. Firms are either paying as a result of the intervention or are ensuring that their tax payments are recorded—which are both important behavioural changes vital to establishing an effective tax collection system.

These results suggest that there is significant potential for improving tax compliance and revenue collection through social recognition programmes. There may be some productive gains from trade in which recognition that is cheap for a tax authority to provide, but which firms deem valuable, is exchanged for new tax revenues.

Mushfiq Mobarak is an associate professor of economics at Yale University, New Haven, US.

Published with permission from Ideas for India , a public policy website.

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