Advancing Prospect Theory and Tax Compliance: A Study of Taxpayer Risk Perceptions

• In Event: 2.04 Behavioral Tax Research

Abstract

We examine the interactive roles of prospect theory’s decision frames and environmental risk on the risk assessment and reporting phases of the tax compliance decision process. Our objective for this paper is to more closely examine the underlying cognitive processes leading to prospect theory’s general prediction that individuals in tax due positions will report more aggressively than those in refund positions. We conduct an experiment with 330 self-employed taxpayers in order to understand the reporting decisions of individuals that are of particular importance to the IRS. We manipulate participants’ tax position (refund vs. tax due) as well as detection or discoverability risk (cash vs. check income). We also measure taxpayers’ narcissism because of its implications on risk assessments. Our results suggest that the underlying cognitive processes for loss frames is more nuanced than previously understood. Specifically, tax due positions (loss frames) distort risk perceptions by causing taxpayers to ignore risk factors (e.g. payment form). Moreover, narcissistic taxpayers appear to completely ignore the effect of decision framing when making risk assessments. Lastly, loss frames diminish risk sensitivity resulting in reporting decisions where taxpayers ignore their own risk perceptions. That is, aggressive reporting is the result of insensitivity to risk.

Authors

• Nicholas Hunt, University of Nevada-Reno

• Govind S Iyer, University of North Texas

• Philip M J Reckers, Arizona State University - Tempe