Originally published on Forbes.com Oct 9th, 2014
I have not written about the tax troubles of Teresa and Joe Giudice, stars of Real Housewives of New Jersey, When I look at clips from the show, I find the title a little disturbing. I was raised by and delivered newspapers and Italian bread to real New Jersey housewives in Fairview and the surrounding towns . I have to wonder what my Aunt Melba would have to say about that bunch. (Melba was not actually my aunt. In my time a boy would address actual real New Jersey housewives as either Aunt or Mrs. depending how close the housewife’s friendship was with one’s mother. So usually you only knew either her first name or her last name.) Regardless, my brother and sister tax bloggers are covering that story so well, I have not had anything to add until now.
Why Me? Why Anybody?
What I found interesting in this piece by Kelly Phillips Erb was that Ms. Giudice was surprised when she was sentenced to some prison time. I have to say that I have just a small bit of sympathy for her perspective. I read a lot of tax cases and it always puzzles me why person A is merely worried about having to pay the tax and some penalties while person B is appealing a long sentence. Many of my readers have an interest in Kent Hovind (Doctor Dino) and some believe that his long sentence was more related to his advocacy of “creation science” rather than his tax related activities.
The answer to the “Why me?” question that anyone doing time for a federal tax crime might ask is found in Jack Townsend’s Federal Tax Crimes (pdf download). The Criminal Enforcement Section of the Department of Justice Tax Division has very limited resources. So they need to extract the most possible deterrence from every single prosecution:
Given the limited resources through the criminal tax enforcement system, CES must coordinate and prioritize. CES does that by prosecuting relatively few cases each year (in recent years from 1100 to 1800 per year), but focusing on the strongest cases where conviction is virtually assured and by picking targets with a sufficiently high profile (for whatever reason) that the conviction might be publicized and encourage compliance by persons who become aware of the convictions.
So here is the sad truth. If you cheat on your taxes, you will probably get away with it. Even if you get caught, you will probably just have to pay the tax plus some penalties. You will even have a chance to convince the IRS you can’t afford to pay and be entitled to Tax Court review if IRS thinks you can afford it. If you fall into the very small group that is selected for prosecution, though, it is extremely likely that you will end up doing some time. That is why it seems like Teresa Giudice was not paying attention to her changed circumstances. As Tax Girl relates in her piece, Ms. Giudice would have likely have been clued in several times that she was likely to get some prison time.
Is There Another Type Of Deterrence That Could Be Used?
It is pretty clear to me that if you are just playing the percentages, tax evasion makes sense for many people. Particularly if you are mainly interested in maximizing current consumption rather than building your net worth. Even the ultimate threat of incarceration if all the breaks go against you is not that intimidating to some. Ron Isley appears to have had a fairly cavalier attitude toward tax compliance throughout his long music career. It finally caught up with him and he ended up doing some time. Here is what he had to say about his experience in prison:
It wasn’t bad at all. I was treated like a king. And 150 people respected me like ‘Elvis Presley is here.’ And I’m thankful to them for that. And a couple of times I did shows. The shows I did for them was the greatest ones in my career.
There is another type of deterrence though, one that eight years in parochial school would ground you well in. That would be guilt. When Clint Eastwood’s “Mr. Kowalski” in Grand Torino makes his long delayed last confession, the first sin, as any parochial school graduate would expect involves the sixth and ninth commandment, which we were especially cautioned against violating. The second though is surprising:
Well, I made a $900 profit selling a boat and a motor, I didn’t pay the taxes. It’s the same as stealing.
Apportioned equally with his other two sins, Mr. Kowalski’s tax crime cost him 3.33333 “Hail Mary”s and 1.666667 “Our Father”s.
That type of deterrence seems to be what Kathleen Delaney Thomas, Assistant Professor of Law at the University of North Carolina, has in mind in her article – The Psychic Cost of Tax Evasion. (Available at SSRN as a download)
Each year, the government loses hundreds of billions of dollars in tax revenue due to underreporting by individual taxpayers. According to standard deterrence theory, policymakers should be able to reduce tax evasion by increasing tax penalties, raising the audit rate, or some combination of the two. This Article refers to these strategies as increasing the “monetary cost” of tax evasion. To date, budgetary limitations and political hurdles have made these strategies difficult for the government to employ.
There is, however, another potential means by which the government can improve tax compliance, apart from raising the monetary cost of evasion. Empirical evidence shows that people experience some form of psychological discomfort when they are dishonest, which may deter them from cheating. This Article proposes employing subtle behavioral interventions that encourage more honest tax reporting by raising the level of psychological discomfort experienced from underreporting. I refer to this approach as increasing the “psychic cost” of tax evasion.
What Makes People Act Ethically
Professor Thomas cites some research that reminding people that ethics are an issue at the right moment can have a significant effect on how ethical they are.
One external factor that has been shown to influence honesty is whether, at the time of decision making, an individual is paying attention to her own ethical standards.
Indeed, studies show that people are more likely to be dishonest if they are not asked to think about moral standards.
In one lab study of attention to moral standards, a group of subjects was asked to recall the Ten Commandments immediately prior to performing a numeric problem-solving exercise, while a control group was asked to recall ten books they had read in high school
In the subgroups that did not have an opportunity to cheat, the average number of problems correctly solved was the same whether or not they had been asked to recall the Ten Commandments. This was expected, since individuals in those groups were presumably honest given their low opportunity to cheat. In the subgroups that had an opportunity to cheat, however, the results were different. The subgroup that was asked to recall ten books from high school claimed to have solved more problems than the other groups, a likely indicator of cheating. On the other hand, the subgroup asked to recall the Ten Commandments reported the same average number of problems solved as the groups with no opportunity to cheat, an indicator of honesty.
Interestingly, it did not seem to matter whether the subjects actually remembered the Ten Commandments. (Here’s a link in case you want a reminder. Just be careful about posting it in public spaces if you don’t want the Freedom From Religion Foundation after you.)
It appears that the mere act of having to think about the Ten Commandments – a proxy for moral standards – encouraged people to be more honest.
There are other factors that can influence peoples tendency to be honest in the moment including their perception of who it is that they may be harming.
Some Suggestions
One idea that is now of limited practical use due to electronic filing is to have paper filers sign their returns at the top of the page, promising to be honest, before they fill out the form. Professor Thomas then gets into some of the ways to modify this for the electronic era
For example, a taxpayer could be prompted to have to check a box confirming that a short statement has been viewed before she can proceed to filling out her electronic form. The statement could be a version of the statement on the Form 1040 signature block, or contain a more concise statement intended to call attention to personal norms against tax evasion. For example, it might simply read: “Reporting false or incorrect information on a federal tax return, including failing to report income that you have earned, is illegal.”
Another possibility would be for the IRS to target specific tax items that are commonly evaded by taxpayers and institute policies to trigger mindfulness among electronic filers with respect to those particular items. A taxpayer might have to read a statement and check a box at several points during the filing process verifying that they do not have certain types of income or tax to report.
In a similar manner, if tax return preparers were required to sign an honor code in connection with each tax return that they prepared, the psychic cost of dishonest reporting might be higher, resulting in more accurate returns. The statement of the honor code could be brief and should not be a cumbersome addition to certifying preparation of a client’s tax return. The honor code statement might be a short summary of the ethical standards under Circular 230, a brief reminder of the potential sanctions for preparing a false or fraudulent return, or both. To mitigate desensitization that might occur after signing the honor code numerous times, the IRS might vary its contents from year-to-year and keep it brief.
Little as I like the prospects of more boxes to check, these ideas have some merit. I think it is possible that software may have eroded certain types of compliance, regardless of honesty. When I did returns by hand, certain lines would have “See instructions” and I would in fact obey that command One of my favorite review notes was RTFI – which stood for Read The Instructions ). Sometimes the instructions would refer to the regulations. You really don’t get that with software.
Another Approach
Although I see the merit in Professor Thomas suggestions, I fear that she is really just taking another step down the punitive path. The IRS has penalties and the most extreme cases imprisonment. Professor Thomas is suggesting that they more effectively employ guilt. That is a sound tactic likely to have some effect on the 96% of the population that is not sociopathic. What surprises me is that no one seems to have tried to use positive motivation to encourage tax compliance. Why doesn’t the government think of ways to celebrate, thank and praise the people who pay the highest amounts of taxes. I wrote about the notion some time ago in a piece titled – Could Saying Thank You Help With The Deficit? Maybe I need to dust it off and rework it.
Afternote
I heard from Professor Thomas (whom in an earlier version I referred to as Professor Delaney, which is her middle name). She confirmed a theory of mine that I had not put in the article. She had twelve years of Catholic education.