A Behavioral Accounting Study of Strategic Interaction in a Tax Compliance Game

This paper reports an experiment on a tax compliance game based on the model of Graetz, Reinganum, and Wilde (1986). A model implication is that the audit rate, β, is insensitive to the proportion of strategic versus ethical taxpayers, ρ. Our hypotheses contrarily predict that auditors with limited rationality use ρ as a cue for adjusting β. The hypotheses assume a simple additive process: β = β′ + β″, where β′ depends on ρ, and β″ depends on a belief about the taxpayer’s strategy. The results show positive associations between ρ and β′, and between auditors’ uncertainty about ρ and β′. The auditors formed incorrect beliefs about the taxpayers’ responses, which affected β″. The auditors incorrectly believed that the taxpayers increased the rate of under-reporting income as ρ increased, and that the taxpayers expected a higher audit rate when the auditors faced uncertainty about ρ. The taxpayers correctly believed that β increased as ρ increased, and responded by decreasing the rate of under-reporting income.