Tax Penalties and Deterrence

The US tax system necessitates a host of penalties to ensure that all taxpayers pay their taxes. This is largely because the system is based on a self-assessment or voluntary compliance model, that is, when taxpayers comply with the law without compulsion or threat. The most frequently assessed penalties are imposed for paying taxes late, failure to make estimated tax payments, or filing returns late. The primary focus of this article is the tax penalties’ effectiveness in deterring noncompliance. The article examines the deterrence effect of tax penalties from five distinct perspectives namely: complexity of the tax code, abatement policy, knowledge and understandability of the tax code, the economic model supporting tax penalties and, the arbitrary method of determining the amounts of penalties.

Complexity of the Tax Code

It is no secret that the U.S. tax code is extremely complicated with thousands of different rules, a myriad of tax credits, deductions and exempt categories than the average taxpayer can keep up with. The article identifies three factors contributing to this complexity namely a lack of congressional planning and coordination based on a central goal, counteracting measures aimed at making the tax fairer to specific constituent groups and, the political market forces that create the law and argues that how the complexity affect the ability of penalties to deter noncompliance largely depends on perception of the law and respect for its integrity.

Knowledge and Understandability of the Tax Code

Related to complexity is taxpayers’ knowledge and understanding of tax rules. For penalties to be effective in deterring noncompliance, taxpayers must know and understand the rules. Unfortunately, few taxpayers know or understand the myriad of rules that make up the tax code. If taxpayers do not know the rules, they can not be expected to understand the specific conditions in the law that will result in specific penalties. Essential to the...