Referent Points and Taxpayers’ Compliance : Insights into Taxpayers’ Risk Preferences for Honest Reporting

Prior research (Schepanski and Shearer, 1995; Alm and Torgler, 2011) relying on prospect theory (Kahneman & Tversky, 1979) shows that taxpayers' compliance is influenced by their perception of whether they owe more or less taxes than they anticipated: Taxpayers are more likely to cheat on their taxes when they perceive that they are in a tax “loss” position as compared to a tax “gain”. Yet what remains to be understood is what exactly constitutes the referent point that separates a tax loss from a tax gain. In an attempt to provide in-depth insight of what constitutes the referent point for taxpayers, we observe taxpayers filing their actual tax return and investigate the extent to which different proxies for the referent point used in prior literature best differentiates between taxpayers' preference to cheat or file their taxes honestly. Our findings indicate that expected asset position is critical to influencing taxpayers' ethical behavior. This revelation is important as it suggests that taxpayers' perceptions influence their tendency to report honestly and comply with tax authorities. Our research is important to the tax authority for determining how to encourage voluntary tax payments, and contributes to the tax ethics literature by clarifying the point which differentiates between taxpayers' tax gain and tax losses. and in so doing, their tendency to file their taxes honestly