Small Business Tax Compliance

Jonathan Lee

Small business owners are responsible for $155 billion of the $441 billion/year U.S. tax gap. The tax gap is the difference between what the U.S. Treasury receives in tax revenues and what is estimated should be received. Multiple academic studies have reviewed the factors that drive small business tax compliance. Additionally, the Organization for Economic Co-operation and Development (OECD) and the U.S. National Taxpayer Advocate (NTA) have been actively researching how to reduce tax non-compliance of small business owners. Although extensive research has been done, the best method to improve small business tax compliance is uncertain. This research examines the factors and motivations that drive small business non-compliance and tests solutions to improve small business non-compliance. The first study combines research done by academics and governmental agencies to provide a comprehensive model of small business tax compliance. Due to the extensive number of variables in the model, a simplified model of ten of the most important factors considered by these research bodies is established. Reliance on past compliance behavior and heuristics are added to the model based on qualitative analyses of a small business tax compliance experiment. Finally, the first study provides an updated review of the small business tax compliance literature along with a review of recommendations for improving small business tax compliance. The second study examines methods for controlling serious tax non-compliance of small business owners who use electronic sales suppression software (ESS). Many jurisdictions around the world are using mandatory electronic monitoring of companies’ sales data to combat this issue. This study examines how behavioral nudges, specifically highlighting the sanctions for using ESS and requiring the separate reporting of cash sales, increase tax compliance and amnesty participation. The results suggest that highlighting sanctions, separate cash sales reporting and the combination of the two nudges act as substitutes, where each nudge or combination of nudges increase compliance by a statistically equivalent amount. Supplemental analyses demonstrate that the mechanisms by which compliance improves vary by nudge or combinations of nudges received, and include desire to minimize tax burden, reliance on past compliance behavior and perceived threat of sanctions.

Small Business Tax Compliance

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