THE DYNAMIC EFFECTS OF TAX AUDITS

Abstract

We study the effects of audits on long run compliance behavior using a random audit program covering more than 53,000 tax returns. We find that audits raise reported tax liabilities for five years after audit, effects are longer-lasting for more stable sources of income, and only individuals found to have made errors respond to audit. A total of 60%–65% of revenue from audit comes from the change in reporting behavior. Extending the standard model of rational tax evasion, we show that these results are best explained by information revealed by audits constraining future misreport-ing. Together these imply that more resources should be devoted to audits, audit targeting should account for reporting responses, and performing audits has additional value beyond merely threatening them.