Exploiting interest in social recognition to raise tax compliance

The infrastructure of Dhaka, the epicentre of the country's economic activities, is bursting at the seams owing to high rates of economic growth, in-migration and urbanisation.

Addressing this issue, subsequently, has become a pressing need. Huge investments are required, which, in turn are only feasible if revenues can be raised.

But, Bangladesh has one of the lowest tax-to-GDP ratios in the world, and boosting revenue collection using audits, fines and other punishment-based methods has proven difficult due to firms' ability to evade payment and the difficulties of enforcing legal sanctions.

Given such circumstances, leveraging firms' interest in social recognition can be used to increase VAT compliance.

For long, universities, charities and museums in the US and other countries have successfully been leveraging people's interest in status and public recognition to generate funding (for example, by naming exhibits or buildings after large donors).

The same approach can be employed for tax collection, and to test the hypothesis, researchers from Harvard and Yale universities teamed up with the National Board of Revenue and ran experiments on 32,432 firms from the Dhaka South area.

The programmes attempted to exploit the firms' interest in social incentives and peer recognition to increase voluntary tax compliance. Eight different types of letters were randomly allocated across sample, and each letter contained either zero, one, two or all three of the following information treatments:

Baseline Information: Firms assigned to this treatment received additional information on the aggregate registration, filing and payment rates for their cluster in the previous period.

Recognition Cards: Firms in this treatment group were told that they would be eligible to receive a gold, silver or bronze recognition card based on their tax compliance and their cluster's tax compliance.

Peer Group Information: Firms assigned to this treatment were told that their tax compliance behaviour would be shared with other firms in their cluster in a subsequent letter.

The results suggest that in the neighbourhoods where some firms were already complying, the promise of exposing information about all firms' tax payment behaviour led to a positive behavioural response and an increase in tax compliance, especially among firms who had not paid in the previous year.

In high compliance clusters, firms receiving the peer information treatment were not only more likely to pay, but conditional on paying, paid more than firms not receiving this treatment.

Combining these two effects, firms receiving the peer information treatment paid 17 percent more on average during the study period than other firms.

The high compliance areas accounted for 66 percent of all VAT revenues generated from the sample area, and the 17 percent increase therefore represents a quantitatively meaningful increase in total revenues.

The estimated increase in revenue from the small sample of firms in the study area alone is Tk 870,000 during the short duration of the experiment.

The increase in payments is derived from a 17-percentage-point rise in firms paying exactly the package VAT amount and a 6-percentage-point increase in firms that make payments exceeding the package VAT amount.

When examining the timing of the increase in VAT payments, it was seen that the spike in payments in the peer treatment group occurred exactly in the month when the intervention was implemented.

Furthermore, the time series of payments in high compliance clusters by those who did not pay the VAT in the previous year shows a substantial increase in payments over the control group during the month of the intervention.

What drove the observed increase in payments may be attenuated by firms who had already committed to paying at the bank but exerted more effort after receiving the treatment letters to ensure that their payments were correctly recorded by the NBR.

In other words, all the estimates reported are the combined behavioural response of firms of increased tax payments and the improved recording of payments.

While improved record keeping is valuable for the NBR, generating new revenues is the bigger prize.

Regardless, the findings clearly demonstrate that firms pay attention to peer recognition letters and react in ways predicted by simple economic theory.

Firms who are deviating from the norm of some tax payments in their cluster, and therefore at greatest risk of “negative” information revelation relative to their peers, react most strongly. 

This suggests that there is significant potential for improving tax compliance and revenue collection through peer information programmes.

Firms are either paying as a result of the treatment or are ensuring that their tax payments are recorded -- which are both important behavioural changes that are vital to establishing an effective tax collection system.

The treatments tested consist of interventions that governments could feasibly implement on a large scale in practice.

An example of a potential programme for the NBR to consider is to mandate market and shop associations to display lists containing tax information about firms in public locations inside shopping centres.

The intervention could act in a similar way to the peer information treatment in the experiment to increase tax revenues.

Further, it may induce additional incentives for firms to become tax-compliant since publicly available information about tax compliance may affect consumer behaviour, perhaps steering customers towards tax compliant businesses.

Scaling this programme to a larger geographic area than that of the study, in addition to the potential changes in consumer behaviour, may lead to increases in revenue far greater than what is predicted by the study.

The writer is a former chairman of NBR.