Studying Efforts to Promote Tax Compliance

Project Summary

Like many other developing countries, Bangladesh is rapidly urbanizing.  Dhaka city, which now accounts for a quarter of the country’s GDP, has been a main locus of urban growth.  However, tax revenue collection has not kept pace with rapid urbanization, resulting in poor or nonexistent public services.  Low rates of electrification and the poor quality of the roads are now frequently mentioned by the government and the private sector as major constraints on further economic growth.  Thus a major priority for the government of Bangladesh is to increase the number of taxpayers and revenue collection in the country.  In the context of VAT, many firms remain unregistered, and even among those that are registered, only 16% actually file monthly VAT returns.

Traditional methods of improving tax compliance have generally relied on “stick” or punishment-based methods: audits coupled with penalties for non-compliant firms.  Such audits may be costly and subject to opportunities for corruption.  In addition, it may be difficult for tax inspectors to assess the true tax liability of the firm even conditional on performing an audit.  An alternative strategy would be to rely on reward-based methods.  Easing registration procedures, paying registration fees or providing financial incentives conditional on registration and filing are examples of inducements that could raise tax compliance.  However, a recent study in Sri Lanka (McKenzie and Woodruff, 2008) shows that such strategies are not very successful once applied in the field.  A different type of reward strategy that has been successful in other contexts involves leveraging the power of social recognition to increase pro-social behavior.

In collaboration with the Dhaka-South Commissionerate of the Bangladesh National Board of Revenue (NBR), we implemented a range of programs that attempt to exploit firms’ interest in social incentives and peer recognition to increase voluntary tax compliance.  We conducted our study as a randomized controlled trial, where we tested the efficacy of various information treatments on tax compliance and payment.

We implemented our interventions through letters to each of the 16,000 firms in our sample.  Prior to the delivery of the letter, we digitized all registration and tax payment data so that we could include detailed information about each firms’ registration and payment information.  In addition, this exercise allowed us to demonstrate to firms that NBR can match tax information to firms, giving credibility to the interventions.  Finally, we assigned randomly assigned geographic clusters of firms to receive zone, one, two or all three of the following information interventions on their letter:

  1. Baseline Information: Firms assigned to this treatment received additional information on the aggregate registration, filing and payment rates of the cluster in the previous period.
  2. Recognition Cards: Firms in this treatment group were told that they would be eligible to receive a gold, silver or bronze recognition card based on their tax compliance and their cluster’s tax compliance.
  3. Peer Group Information: Firms assigned to this treatment were told their tax compliance behavior would be shared with other firms in their cluster in a subsequent letter.

Our results suggest that in clusters where some firms are already paying their taxes (>15%), the promise of exposing information about all firms’ tax payment behavior led to a positive behavioral response and an increase in tax compliance, especially among firms who had not paid in the previous year.  We did not find any increases in tax compliance or payment stemming from the baseline information or recognition cards treatment.

Our findings indicate that firms pay attention to peer recognition letters and react in ways predicted by simple economic theory.  Firms who are deviating from the norm of some tax payments in their cluster, and therefore at the greatest risk of a “negative” information revelation relative to their peers react strongly to this intervention.  This suggests there is a significant potential for improving tax compliance and revenue collection through peer information programs.

Research Partners:
Raj Chetty (Harvard University), Monica Singhal (Harvard University), Bangladesh National Board of Revenue (NBR), International Growth Center (IGC), Poverty Action Lab (J-PAL)

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