How Behavioral Economics Boosted Tax Compliance in the Dominican Republic

In the world of tax collection, even small improvements in compliance can have massive financial implications for governments and societies. A recent study, "The $100 Million Nudge," demonstrates how a simple intervention, rooted in behavioral economics, significantly increased tax compliance among firms, resulting in a dramatic boost to public revenue.

Tax compliance has always been a challenge for governments around the world. Non-compliance doesn't just affect government budgets; it also distorts competition and weakens the overall economic system. Our research sought to explore whether "nudges"-subtle behavioral interventions-could address this issue at a large scale, particularly focusing on business compliance.

An Experiment in the Dominican Republic

We designed a natural field experiment in the Dominican Republic to test this hypothesis with firms as the participants. Through a collaboration with government tax authorities, we aimed to show how minor adjustments in communication could translate into significant improvements in tax payments.

In our study, firms were randomly assigned to different groups, with some receiving personalized letters emphasizing potential prison time for tax non-compliance and others, the potential public disclosure of their punishment, a social sanction. This approach draws on principles of behavioral economics, leveraging the idea that individuals are influenced both by well-communicated reminders of penalties and by the opinions and norms of those around them. If most firms are paying taxes, non-compliance becomes socially unacceptable.

The intervention was simple but scalable, reaching thousands of firms at minimal cost.

Big Increases in Tax Compliance

The results of our experiment were striking. Firms that received the letters with reminders of prison time increased the amount of taxes they paid by an average of 44% compared to those that did not receive any intervention, and those that received the message on potential public disclosure increased it by an average of 18%. This improvement translated into an additional $184 million in tax revenues in a country that, as of 2018, had a roughly 13% tax-to-GDP ratio, compared to 33.5% in developed countries.

One of the most remarkable findings was the cost-effectiveness of the nudge. Given the minimal expenses associated with sending out letters, the return on investment was extraordinary, highlighting how behavioral insights can be used to improve government efficiency without large-scale structural changes or punitive measures.

Critically, our experiment does not stand alone. It echoes the results of several other successful nudge-type experiences with boosting tax collection. A study carried out by the IDB's s Research Department in Argentina, for example, found that embedding messages into tax bills on penalties for non-payment increased compliance by 9%. A reward given to randomly selected on-time taxpayers-a sidewalk built by the government in front of their home-in another IDB experiment in Argentina, also increased the likelihood of those taxpayers' compliance over the next three years, this time by seven percentage points. Most impressive of all, it created a contagion effect among neighbors who witnessed the government using public money constructively while changing their beliefs with respect to social norms: the tax compliance of their neighbors. As a result, delinquent taxpayers who were neighbors of the sidewalk winners were 7.5 percentage points more likely to pay on time in the future.

The success of our experiment and these others at the IDB opens new avenues for policymakers looking to enhance tax compliance through non-punitive methods. Nudges, including those that appeal to social norms, can complement traditional enforcement mechanisms, ultimately leading to fairer and more efficient tax systems.

At the same time, our findings stress the importance of rigorous testing and evaluation. Behavioral interventions, while often successful, need to be carefully designed and tailored to specific contexts to maximize impact.

Our study highlights the power of behavioral science to solve complex policy issues, a goal aligned with government efforts to improve public services and maintain fairness in the tax system. As governments continue to seek ways to increase compliance and revenue without burdening taxpayers with additional enforcement costs, the insights from this and other experiments at the IDB could play a pivotal role.

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