The Effect of Perfect Monitoring of Matched Income on Sales Tax Compliance: An Experimental Investigation

Noncompliance is a quantitatively important phenomenon that significantly affects revenue sources for governments. This phenomenon raises challenging questions about the determinants of tax reporting and about the appropriate design of a tax system. This paper provides specific empirical insights using an experimental approach to evaluate the effects of systematic sales tax monitoring and the determinants of sales tax compliance. The results indicate that if perfect monitoring is instituted without other complementary policies, an increase in tax revenues is not the likely outcome. Once people have chosen their level of tax compliance, a stepped up policy of increased monitoring aimed at reducing fiscal fraud may not necessarily increase tax revenues. The reference-dependent effect observed in the data suggests that individuals will try to recover their losses following any policy changes even if it means taking more risks.