How a Simple Nudge Can Bring in Tax Dollars

It’s been said that death and taxes are life’s only certainties. Unlike death, however, taxes can be put off. Knowing this, governments expend considerable energy “motivating” taxpayers to file on time. Yet despite threats of hefty penalties and fines, laggards persist.

In recent years, policy-makers have turned to behavioural economics to improve behaviours across a number of domains, including tax compliance. Introducing a simple message based on a social norm, such as “Nine out of 10 people pay their taxes on time,” has proven effective. But can organizations be similarly nudged?

There’s reason to believe that nudges may not work for companies. Corporate managers have the training and bureaucratic support that mitigates biased decision-making. Employee groups also tend to act rationally and members share responsibilities; typical social-norms nudges may not be effective. On the other hand, organizations are made up of individuals.

A recent study is the first to assess whether a behavioural approach to tax compliance, such as providing planning prompts, is effective with organizations.

How was the study designed?

This field experiment, conducted during the 2013 and 2014 tax years, examined the tax-paying behaviour of all organizations in Ontario that failed to file timely annual returns for a payroll tax. Organizations were randomly assigned to receive one of two letters: a standard late notice or a revised experimental late notice that reorganized information into planning prompts—essentially, step-by-step instructions for when, where and how to file a return. Planning prompts have been shown to be effective at motivating behaviour changes across a variety of domains. But they haven’t been tried as a tool for motivating tax compliance, nor has their effectiveness within organizations been tested.

What did the study find?

• Organizations that received the planning prompt intervention (the experimental late notice) were significantly faster in filing their taxes. 

• Across the two tax years studied, the experimental letter brought in approximately $600,000 more in remittances before additional collection efforts began 10 days later. It also saved the government more than $11,000 in collection costs. Had the experimental letter been sent to all organizations that were late filing their annual return across the two tax years, the government would have received an additional $1 million in remittance and saved approximately $20,000 more in collection costs.

• Repeated exposure to the experimental letter over the two tax years did not diminish its effectiveness. If anything, it appears that the experimental letter was more effective for organizations previously exposed to it.

What do I need to know?

This study is among the first to show that nudges can change the behaviour of organizations, not just individuals. It also shows that certain nudges can be effective over time—they don’t only work when they’re new—but they must be delivered at the right time.

It’s often assumed that companies that are overdue with their tax payments lack the ability to pay. Otherwise why would they risk incurring large penalties? The researchers in this study believe that providing a concrete plan (when, where and how) can help organizations overcome barriers such as procrastination and forgetfulness, and nudge them to act on their existing motivations. They showed that a behaviourally-informed late notice that included an explicit deadline and specific instructions on how to follow through—delivered close to when a decision had to be made—was a winning nudge in the right direction. 

One would think that spoon-feeding such basic planning information to organizational managers would have little effect. The organizations targeted know the deadlines and how to file a tax return. Indeed, in this study, more than 97 per cent had previously filed the payroll tax return. And all organizations received a requirement-to-file letter before the deadline that provided information on when and how to file. 

Yet the key insight of this study is that organizing the information into a simple step-by-step plan can reduce the friction of following through. There’s a lesson here for those working to improve organizational tax compliance—perhaps the stick is not the only way to get results. Leveraging behavioural science can be an effective tool at motivating action.

Applying behavioural insights to corporate tax compliance offers a trifecta of benefits. Organizations are spared extra penalties and interest. Treasury departments save collection costs, including staffing of call centres and procurement of collection agencies (in Ontario, where this study was conducted, collection costs amount to roughly two cents for every dollar collected). And state coffers are filled with taxes that may otherwise not have been paid. Not bad, given that implementing this “nudge” involves zero marginal costs. 

The Ontario government is a believer. The behavioural approach to late payment notices is now standard procedure in that province. 

Study title: Effectiveness of Planning Prompts on Organizations’ Likelihood to File their Overdue Taxes: A Multi-wave Field Experiment
Authors: Nicole Robitaille (Smith School of Business), Julian House (Treasury Board Secretariat, Government of Ontario), and Nina Mazar (Questrom School of Business)
Published in: Management Science (available online)