How to Improve Payroll Tax Compliance of Small Firms? Evidence from a Randomized Field Experiment

How can tax compliance of small firms be improved? Cooperating with the Bulgarian tax authorities, we conducted a randomized field experiment to study the effect of deterrence measures and moral appeals on tax compliance of small firms in an emerging economy. We randomized the individual audit probability of firms (1%, 10%, 40% or 60%) to a set of SMEs and introduced a novel form of moral appeals varying the information about the benefits a taxpayer receives from tax-financed public goods to a different sample population. Our focus is on payroll taxes, a type of tax that faces the challenge of limiting third-party reporting and which is rarely studied in existing tax-compliance work. Using administrative tax return data with monthly frequency, we show that both deterrence measures and moral appeals significantly improve payroll tax compliance, with the treatment effect of deterrence treatments stating a high audit probability being approximately 50% larger than the moral-appeal effect. We further show that treatment responses are particularly large for larger firms and labor intensive industries. A cost-benefit analysis reveals that the experiment-induced tax revenue gains considerably outweighed the costs of the experiment