Referent points and taxpayers’ compliance: Insights into taxpayers’ risk preferences for honest reporting

Prior research (Schepanski and Shearer, 1995; Alm and Torgler, 2011) shows that taxpayers’ compliance is influenced by whether they are in a tax gain or tax loss position relative to their withholding status. 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”. The academic literature is currently unclear as to how taxpayers internally define tax losses and tax gains when making compliance decisions. We incorporate a prospect theory (Kahneman & Tversky, 1979) perspective to ascertain how taxpayers separate out tax gains from tax losses. We incorporate field survey data from 69 United States taxpayers (an approximate 25% response rate) recruited as part of a university volunteer income tax assistance (VITA) program which targets low income filers, a critical policy group regarding savings and tax behaviors. Information from their actual tax returns was merged with questionnaire data obtained prior to and after their discovering their tax position of refund or additional payment. Utilizing ordinary least squares (OLS) modeling, we examine the referent point that differentiates between taxpayers’ preference to cheat or file their taxes honestly. Findings suggest that the expected asset position, which is the amount taxpayers’ expect to pay or receive from filing taxes, is critical to influencing taxpayers’ compliance behavior. This revelation is important in the context of the literature as it suggests that taxpayers’ tendency to report honestly and comply with tax authorities is a function of current perceptions, and from a practical perspective, is neither entirely dependent upon historical tax position, nor the withholding of taxes owed by the tax authority. Thus, our research provides insight to tax authorities for determining how to encourage voluntary tax payments and encourage taxpayers to file honestly. Our research extends prospect theory research by providing insight into individuals’ referent point and risk taking behavior.