Cash and the Hidden Economy: Experimental Evidence on Fighting Tax Evasion in Small Business Transactions

Abstract

Increasing the tax compliance of self-employed business owners—particularly of trade-specifc service providers such as those involved in construction and repair work—remains an ongoing challenge for tax authorities. From a compliance point of view, cash transactions are particularly problematic when services are paid for on the spot, as these exchanges are difcult to audit. We present experimental evidence testing ten diferent policy strategies rooted in the enforcement, service, and trust/social paradigms, in a setting that allows payment either via a transaction that directly reports income for tax collection purposes or in cash, where taxes are only collected on reported income. Our sample includes both a typical subject pool of students, as used in most previous studies, and non-students who are active within service industries characterised by the opportunity to engage in cash transactions. While our comparative results show that, for both student and non-student participants, interven tions that rely on greater enforcement by the tax authority have the greatest efect on compliance in our cash economy setting, treatments involving cooperative elements may be similarly efective in enhancing tax compliance. Given their efectiveness, cooperative approaches should therefore be considered for addition to the policy mix if implemented at relatively low costs, making both carrot and stick approaches promising to increase compliance in an environment where cash-for-service payments ofer a common beneft for small businesses and their customers from implicit collusion that enables tax evasion