Costly False Detection of Errors and Taxpayers Rights Legislation: Implications for Tax Compliance, Audit Policy and Revenue Collections.

In July, 1996, Congress passed the Taxpayer Bill of Rights 2 (T2). T2 resulted from a series of initiatives aimed at protecting honest taxpayers, particularly those affected by Internal Revenue Service (IRS) enforcement actions. This study incorporates taxpayer rights considerations into a strategic model of reporting and auditing, and examines the effect of false detection and costly error correction on taxpayer equity, tax evasion and revenue collections. The model also considers proposals to shift honest taxpayer costs to the tax authority. The study finds that: (1) tax evasion can be deterred completely, but only at honest taxpayers' expense, (2) costly false detection errors increase tax authority revenue collections in some cases, and (3) although tax authority reimbursement of honest taxpayer costs can restore equity, it also may increase evasion, producing additional revenue loss. These results highlights the trade-off between detecting evasion and protecting taxpayers' rights. The study also provides insight to policy makers for balancing taxpayers' rights, revenue needs and cost considerations..