Corporate Income Tax Compliance: A Time Series Analysis

Article excerpt


Though considerable work has recently been done on individual income tax compliance, the area of corporate income tax evasion has been virtually neglected. This is particularly surprising given the popular belief that corporate noncompliance is widespread and substantial. Indeed, certain Internal Revenue Service (IRS) findings appear to suggest that there is some merit to this view. In 1979, corporations accounted for 58.7 percent of recommended additional taxes and penalties, despite the fact that they accounted for only 15.5 percent of gross collections and 6.9 percent of all returns examined [Annual Report of the Commissioner of the Internal Revenue, 1979]. Recent IRS estimates report that the gross tax gap for corporations increased by almost 146 percent between 1973 and 1987, from $8.8 billion to $21.4 billion, and was projected to reach $31.1 billion by 1992.(1)

The rising corporate tax gap has focused attention on the loss in tax revenues due to corporate noncompliance. Moreover, it may be the case that reports of rising corporate noncompliance have an adverse influence on the compliance behavior of individuals. Various suggestions have been proffered as to how to reduce the corporate tax gap. It has been argued, for example, that a reduction in marginal tax rates may encourage compliance and, hence, increase tax revenues. There is, however, no clear-cut theoretical or empirical support for the proposition that lower marginal tax rates lead to improved compliance. On the other hand, there is the prevalent belief that the IRS is too soft on corporations and needs to implement more aggressive enforcement strategies such as increased audits or harsher sanctions for evaders.

In light of the apparent magnitude and growth of corporate noncompliance, the time seems right to assess its determinants. This study analyzes aggregate time series data on corporate compliance in an attempt to examine the impact of alternative policy variables such as audits and tax rates on corporate noncompliance. The paper is organized as follows. The next section provides a brief review of the existing literature on both corporate and individual income tax compliance. The third section discusses the specification of the compliance equations, data, and estimation issues. Regression results are presented in the fourth section and a summary and conclusion are provided in the fifth section.

Previous Research

Following the seminal contribution of Allingham and Sandmo [1972], the literature on income tax compliance has centered on the compliance decisions of individuals. Theoretical models of individual income tax compliance typically employ either an expected utility or a game-theoretic framework to analyze the individual's compliance response to factors such as the marginal tax rate, income, penalties, and the probabilities of detection [Allingham and Sandmo, 1972; Srinivasan, 1973; Yitzhaki, 1974; Koskella, 1983a, 1983b; Greenberg, 1984; Reinganum and Wilde, 1985, 1988; Erard and Feinstein, 1994]. Regardless of the paradigm employed, the predictions of these models are plagued by ambiguities and are extremely sensitive to the underlying assumptions. In these circumstances, empirical research is of crucial importance in providing guidance to the appropriate path for future policies.

The empirical work to date, however, presents conflicting evidence as to the relative importance of sanctions, audit rates, and marginal tax rates on tax compliance. In general, sanctions are negatively related to evasion in theoretical models of tax compliance but are often statistically insignificant in empirical studies [Allingham and Sandmo, 1972; Witte and Woodbury, 1985]. Audit rates are significant for some but not all audit classes [Dubin and Wilde, 1988] and the relationship between the marginal tax rate and level of compliance is the subject of much debate [Yitzhaki, 1974; Clotfelter, 1983; Graetz and Wilde, 1985; Slemrod, 1985; Dubin et al. …