Ambiguity, Audit Errors, and Tax Compliance

Abstract

We examine the impact of tax law ambiguity and tax audit errors on tax compliance in a setting where litigation is allowed. A decrease in audit errors discourages aggressive reporting and leads to fewer audits and trials. A reduction in tax ambiguity, however, has indeterminate effects on aggressive reporting and litigation frequencies. A more effective tax audit benefits taxpayers with relatively strong cases but not those with weak ones. A tax cut encourages aggressive reporting and lowers net revenue. An increase in the penalty, however, leads to less aggressive reporting and higher net revenue without making anyone worse off.