How ‘nudges’ can improve tax compliance

Tax authorities are always looking for ways to get citizens to pay up in time. One useful strategy could lie in writing clever payment reminders, an experiment from Dominican Republic shows.

A team of researchers managed to raise the Caribbean nation’s tax revenue by $193 million in 2019, simply through effective “nudges”. “Nudging” is a psychological tool used to change people’s behaviour. Countries have used the method to frame warning letters and messages for taxpayers who do not comply.

Justin E. Holz and others carried out the experiment in collaboration with the Dominican Republic’s tax authority. Evasion in the country is around 60%, the researchers say in their paper in the US National Bureau of Economic Research.

The nudges that the team sent with deadline reminders included warnings about prison sentences or public disclosures. The messages went to over 56,000 firms and 28,000 self-employed workers. Tax revenue from both rose significantly after the experiment.

For firms, the threat of prison time worked better than the threat of public disclosure, raising tax revenues by 45%, or $5,300, on average. The public disclosure warning helped lift the tax payments by 19%. The impact of the two message types was roughly the same on individuals, the paper says.

A message that any mistake may be treated as an active choice had negligible effect, but its impact was high when the message went with a prison warning. Larger firms reacted more strongly to nudges than smaller ones.

In 2019, the government collected an additional $193 million, equivalent to 0.23% of the country’s GDP in 2018, as tax revenue. Of this, over $100 million tax would not have come if not for the experiment, the authors claim.

Also read: The $100 million nudge: increasing tax compliance of businesses and the self-employed using a natural field experiment

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