Self-Audits, Penalties, and Taxpayer Compliance .

This study investigates the introduction of self-conducted audits ("self-audits") into a reporting and auditing game between taxpayers and a taxing authority. When taxpayers are not expecting self-audits and when the number of audits is limited by budget constraints, penalty-free self-audits can increase taxpayer compliance when the cost of self-audits is sufficiently low. However, when taxpayers are expecting the possibility of penalty-free self-audits, compliance can be lower than it would have been without self-audits. Therefore, early "test-marketing" of penalty-free self-audits may indicate that they increase taxpayer compliance, while subsequent establishment of penalty-free self-audits can result in decreased compliance. Nonetheless, self-audits (with penalties) can be desirable additions to a taxing authority's tax-collection technology. If the cost of a self-audit is sufficiently small (relative to regular audits), the introduction of self-audits can increase taxpayer compliance when taxpayers are anticipating a reporting and auditing game that includes self-audits. If the proportion of truthful taxpayers is sufficiently large (when only regular audits are used), self-audits with penalties yield higher compliance than do penalty-free self-audits.