Tax Audit Expectation Updating: Direct and Indirect Effects of an Audit

2025.

Kuchumova (Paramonova) Y. A., Кумачева С. Ш.

In recent years, an emerging body of empirical research has shown that tax audits, in addition to recovering unpaid taxes (direct effect), increase future tax compliance (indirect or dynamic effect). This literature also suggests that updating expectations induced by audit experience plays an important role in explaining this indirect effect. However, exactly how taxpayers form their beliefs and adjust them based on audit experience remain open questions. This paper extends tax compliance theory by providing a new framework for describing how taxpayers construct their subjective beliefs about audit probability and then analyzing the dynamic effects of tax audit on evasion behavior. Given that Bayesian belief updating is informationally infeasible for taxpayers, we propose several possible mechanisms of beliefs updating based on audit experience that represents different types of taxpayer's characters. Under the heuristic updating mechanism, which turns out to be the most realistic, our model allows us to sustain all observed patterns of the specific indirect effect: it is positive for non-compliant taxpayers, persists but attenuates over time. Additionally, we consider the case when, through an audit, a taxpayer can get insight information and learn the true audit rule. Analyzing this case, we find that revealing information is not beneficial for the tax authority.

Keywords: Tax audit, updating, Subjective beliefs, dynamic effect, tax audit, subjective belief, updating