The impact of multiple component reporting on tax compliance and audit strategies

Prior studies of the strategic interaction between taxpayers and the tax authority have focused on reported net taxable income and on audit policies designed to discover potential misstatement of that single item. This paper extends the literature by modeling taxpayer compliance behavior and tax authority audit strategies within the context of a multidimensional report of taxable income. Specifically, the study analyzes the impact of component reporting requirements on taxpayer incentives to misstate their tax liability. It also allows the tax authority to tailor its audit policy to consider all tax return information. In particular, the model permits the tax authority to audit return components sequentially: the investigation of a second component is conditional on the results of the first component's audit. The study finds that partitioning taxable income into a multi-component report reduces overall tax evasion and increases tax authority net revenue collections relative to a single-report model of net taxable income. However, the impact on predicted evasion is not uniform across taxpayers. While some taxpayers reduce evasion, others with multiple opportunities to evade are more likely to do so when faced with multi-component reporting requirements.