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ESSAYSONTAXPREPARERIMPACTONTAXREVENUECOLLECTIONAND CODECOMPLIANCE By RAYMONDAL.BURGMAN ADISSERTATIONPRESENTEDTOTHEGRADUATESCHOOL OFTHEUNIVERSITYOFFLORIDAINPARTIALFULFILLMENT OFTHEREQUIREMENTSFORTHEDEGREEOF DOCTOROFPHILOSOPHY UNIVERSITYOFFLORIDA 2002 Copyright2002 by RaymondaL.Burgman Tomynephews ACKNOWLEDGMENTS Itisimportanttopray. Therefore,Iamthankfulformyownresilience. Several attributescanmakeagoodeducationgreat. Forexample,ifonereceivesagood education,itispossibletogotothefishmarketandbuyfish. However,ifonereceivesa greateducation,itispossibletogotothepondandcatchasmanyfishasyouneed. IfeelasifIreceivedagreateducationattheUniversityofFlorida. Thescholars intheDepartmentofEconomicstaughtmetothinkandreason. Thereisawealthof knowledgeforastudenttotapinthedepartment. Iwasprivytoasmallportionofthat knowledge. ImustacknowledgethewisdomIreceivedfrommysupervisorycommittee. Theytookthetimetolistentomyconcernsandguideme. ThisisadebtwhichIcannot repay. Dr.JonathanHamiltonhasbeenbeyondgenerous. Henevergaveuponme, whichmotivatedmetoworkevenharder. Iwishtothankhimforthewayheassistedme indevelopinganacademicfocusandmycareerasaneconomist. Dr.StevenSlutsky motivatedmefromthebeginningofmygraduatecareerwithhisengaging microeconomictheorylectures. Iowehimadebtofgratitudeforhiseconomicintuition thatIcouldonlyglimpseaminutiaof. Dr.MeganWerneristhelightattheendofmy datatunnel. Beginningwithstatisticsandprobability,sheshowedmethemagicof numbers. Econometricsisdeeperthanmostpeoplerealize. Iamgratefulforher knowledgeoflogitregressionanalysis. Dr.GaryMcGillalsohelpedwithmyempirical work. Withouthim,Iwouldnothavefoundauditprobabilitydata. IV IalsowishtorecognizevariousfriendsImadewhileattheuniversity. Iwantto thankmycoffeebreakfriendandconfidant,SangHyupLee,whofoolishlyadvisedme. However,Ihadtolearnthehardway. Iunderstandsomuchmorebecauseofhim. As forfriendsoutsidetheDepartmentofEconomics,JulieNguyenandAmberMcCann,I saythankyoutothem. Theylistenedtomoreeconomicsthantheyprobablywantedto hear. However,Ibelievethattheyarebetterpeopleforknowing. IalsowishtoacknowledgetheConsortiumforStrongerMinorityPresencein LiberalArtsInstitutions. AsateachingfellowatDePauwUniversity,Iwasamemberof adissertation-readinggroupalongwithDr.TiyiMorris,Dr.KimEllis,Dr.Matthew Oware,andDr.AnneFemald. Theyprovidedmewithmanyhelpfulcomments. Myfamilydeservesathankyou. EventhoughtheyhadnoideawhatIwasdoing inschool,theyheldontothebeliefthatIwouldfinish. Mysisterhasbroughtmemore joyinthelastfewyearsthananyonecanimagine. Ithankherformakingmylifefull. v 1 TABLEOFCONTENTS page ACKNOWLEDGMENTS iv ABSTRACT viii CHAPTERS 1 TTHHEETUANXITPERDEPASRTEART'ESS:RORLEEFIONRTMHEISPSEURESSONAANLDINECCOOMNEOMTIACXSRYESSTEEAMRCIHN LITERATUREREVIEW 1 TaxReformIssues 1 CurentTaxPolicy 3 AuditingTaxReturns 5 TaxPreparers,Ethics,andStandards 6 LiteratureReview:TaxEvasionandTaxPreparerUse 1 Conclusion 16 2 ATHEORETICALMODELOFTAXPREPARERIMPACTONTAXAUDITAND COMPLIANCERATESWITHPERFECTADVICE 18 Introduction 18 PreviousStudies 22 ModelAssumptions 23 TheGameTreewithSelfPreparationbyAllTaxpayers 24 TheGameTreewithPerfectAdvice 36 ProbabilityComparison 48 Conclusion 49 3 ATHEORETICALMODELOFTAXPREPARERIMPACTONTAXAUDITAND COMPLIANCERATESWITHIMPERFECTADVICE 53 Introduction 53 TheGameTreewithUnobservableImperfectAdvice 53 TheGameTreewithObservableImperfectAdvice 65 ProbabilityComparison 76 Conclusion 77 vi 4 ANEMPIRICALMODELOFTHEINFLUENCEOFAUDITLEVELSANDTAX POLICY CHANGES ON TAX PREPARER USAGE BY TAXPAYERS WHO ITEMIZE 81 Introduction 81 RevenueReconciliationActof1993 82 TaxPreparerUseStudies 86 Data 87 ModelandVariableDefinitions 90 SampleSelection 96 Results 99 Conclusion 117 5 EMPIRICALRESULTSINCOMPARISONTOPREVIOUSRESEARCH 118 Introduction 118 SampleSelection 119 Results 120 Conclusion 128 6 CONCLUDINGREMARKS 129 APPENDIX A COMPARATIVESTATICRESULTS 133 B FORMSUSEDINEMPIRICALMODEL 139 C CHAPTER4MARGINALEFFECTS 140 LISTOFREFERENCES 145 BIOGRAPHICALSKETCH 153 vii AbstractofDissertationPresentedtotheGraduateSchool oftheUniversityofFloridainPartialFulfillmentofthe RequirementsfortheDegreeofDoctorofPhilosophy ESSAYSONTAXPREPARERIMPACTONTAXREVENUECOLLECTIONAND CODECOMPLIANCE By RaymondaL.Burgman August2002 Chair: JonathanH.Hamilton Department: Economics InChapter1,taxregulationsandprocedureshaveevolvedintoacomplexsystem thatrequiresprofessionaltrainingtoensureaccuratecompletionofafederaltaxreturn. Taxconsultantscontinuallyupdatetheirknowledgetoremaincompetitive. First,I discusscurrenttaxpolicy,alternativestothecurrentsystem,andamendmentstothe currentsystem. Anexpositionofthestandardssetbyvariousprofessionalorganizations andthefederalgovernmentfortaxconsultantsfollows. InChapters2and3,thecurrenttaxevasionliteratureprimarilyinvestigatesthe relationshipbetweentheInternalRevenueServiceandthetaxpayer. Additional theoreticalaswellasempiricalextensionsintotheimpactthatpreparershaveontaxpayer reportingbehavioraswellasgovernmentalauditingarenecessary. Thisdissertation developsananalyticmodeltoinvestigatetherelationshipthattaxpreparersplayinthe taxreportingdecisionoftaxpayers. Thetaxpayerandthetaxagencyplayasequential gamewherethetaxpayerhastheopportunitytoseekadviceabouttaxliability. Thetax agencydecidesifanauditisappropriate. Thisdissertationsolvesthereportingandaudit probabilitiesforthestatesoftheworldwhereadviceisandisnotavailable. InChapters4and5,theempiricalmodelinvestigatestheevolvingandimportant relationshipthattaxpreparersplayinthetaxreportingdecisionoftaxpayers. Iusethe 1994IndividualPublic-UseMicrodataFile(IMF)toinvestigatewhytaxpayersseekthe adviceoftaxprofessionals. Ienhancethetypicalmodelwiththeinclusionofaudit probabilitiesbasedonresidence. Themodelalsotakesintoconsiderationchangesinthe taxlawsincetheTaxRevenueActof1986. Theresultsbasedonemploymentstatus, age,maritalstatus,andcomplexity. Taxlawchangesandauditprobabilitiesalso influenceprepareruse. IX CHAPTER THETAXPREPARER'SROLEINTHEPERS1ONALINCOMETAXSYSTEMIN THEUNITEDSTATES:REFORMISSUESANDECONOMICRESEARCH LITERATUREREVIEW TaxReformIssues TheInternalRevenueService(IRS)isthelargestbureauoftheTreasury Department. "TheIRSisresponsiblefordetermining,assessing,andcollectinginternal revenueintheUnitedStates. Thisrevenueconsistsofpersonalandcorporateincome taxes,excise,estate,andgifttaxes,aswellasemploymenttaxesforthenation'sSocial Securitysystem”(http://www.ustreas.gov). Reformingthetaxcollectionprocesswasacentralconcernofthepresidential electionof1996intheUnitedStates(UnitesStatesCongress1997). Inlate1997, CongressaddressedtheproblemwhentheyquestionedInternalRevenueService(IRS) agents. TaxpayersaccusedtheIRSofimpropertreatmentduringtheauditprocess(Mintz 1997). Oneoptionwouldbetoreplacethecomplicatedincometaxstructurewithoneof thefollowingtaxschemes:retailsalestax,value-addedtax,flattax,orpersonal consumptiontax. Researchonimplementationof,compliancecostof,andthetax revenuegeneratedfromeachprogramcontinues(BakijaandSlemrod1996). Eachcollectionsystemhasadifferentstructure. Theretailsalestaxoperatesthe sameasthesalestaxusedby45ofthe50states. Thevalue-addedtaxcollectsrevenue basedonthevalueofgoodsateachstageofproductionanddistribution. Theflattax,the cornerstoneofSteveForbes'1996Republicanpresidentialnominationcampaign,says thateachindividualpaysasingleflatrate(GaleandHoltzblatt1997). Lastly,the 1