Abstract

Behavioral economics challenges the notion that humans are always rational and capable of making good decisions. Humans often rely on various heuristics under uncertainty making them irrational at times. Heuristics is a mental shortcut or rule of thumb that simplifies decision-making and problem-solving. In this paper, we discuss the use of behavioral economics in improving tax policies by considering the status-quo bias, framing, and conformity heuristics. Status-quo bias causes taxpayers to stick to their default condition (i.e tax non-payment.) Framing refers to the formulation of the problem and how the information is presented to the decision maker. Further, conformity encourages taxpayers to pay their taxes by appealing to personal and social norms. Using these heuristics, I will explore how tax collection policies can be refined to minimize financial losses for the government.

I. Introduction

Einstein said, “The hardest thing in the world to understand is the income tax,” which remains relevant today as tax computation and the payment process remain complicated. This leads to procrastination and non-payment, creating detrimental financial losses for the government. For example, In the US, between 2014 to 2016, the tax gap, the difference between true tax liability and amount paid on time, was $496 billion (IRS, 2022). The tax liability increased by more than 23% between the two periods, 2011-2013 and 2014-2016 indicating a need to change the tax policy. Studies show that tax policies that implement behavioral economics are more impactful and efficient compared to traditional tax policies (World Bank Group, 2018; Behavioral Insights Team, 2012; OECD, 2021). Behavioral economics assumes that humans have limited capability to compute large amounts of data at once.

The World Bank splits the tax-paying process into four stages: understanding, deciding, declaring, and paying (World Bank Group, 2008). Behavioral policies can improve compliance at each stage by addressing systematic errors which are “cognitive biases or heuristics that consumers use to make pragmatic choices that are not rational or optimal ”(Kahneman, 2011). This paper will explore three main biases, namely Framing, Status quo, and Conformity, and take them into account to create a viable tax policy that targets the four stages mentioned above.

Every year, more than 170 million taxpayers have to file taxes in the US. With the tax code becoming increasingly complex, taxpayers have to spend a significant amount of time filling out the 1040 form, various schedules and keeping records of their transactions. This leads to some individuals failing to pay taxes in a

timely manner or take up benefits such as the Earned Income Tax Credit (EITC). 

II. Framing

Kahneman and Tversky define framing as the formulation of the problem and how the information is presented to the decision maker (Kahneman and Tversky, 1981). This shows how information is presented impacts the decision-making process. Framing is indeed a bias, as it leads to decision-makers making different choices with identical information. Their choices are not uniform. Governments can use this to their advantage by presenting income tax letters in a way that encourages taxpayers to pay their accurate tax amount on time hence improving compliance.

A study by Jones (2017) further found that at least 30% of the extra revenue accrued to the government from overwithholding arises from loss-averse behavioral response. He claims it is possible to manipulate a taxpayer’s perception of what constitutes a gain or a loss—potentially through relatively cheap manipulations to phrasing or presentation. Loss framing could be induced to increase the take-up rate of a specific tax-based incentive in targeted populations. Gain framing could be induced to reduce evasion motives among traditionally non-compliant groups, potentially in a cost-effective manner when compared to audits.

Hard Tone vs Soft Tone

A study in Poland (World Bank Group, 2018) showed the effect of using a hard tone versus a soft tone on tax compliance. To do so, they created two types of letters: public good positive and public good negative, where both letters informed the taxpayer how the tax revenue would be used to provide public goods such as preschools, schools, roads, and safety. The public good positive treatment creates

a perception of the taxpayer as a responsible member of their community who is helping provide public goods by paying their taxes. This appeals to the taxpayer on a very personal level making them aware of the public benefitting infrastructure provided by the government, which encourages them to pay on time. The public good negative treatment frames non-payment as an implicit threat where all the municipal benefits currently enjoyed would be lost without sufficient tax revenue. It uses the principle of loss aversion to motivate taxpayers to pay. The reaction of the taxpayer, as a result, will be to pay taxes to avoid losses. Loss aversion is defined as: “changes that make things worse (losses) loom larger than improvements or gains” (Kahneman, Knetsch, and Thaler, 1991). The key contrast between both approaches is the “inability of the government to continue providing” vis-à-vis “potential losses suffered by the individual in the future”. These treatments are considered soft tones as they do not mention any form of punishment for non-payment.

To create a comparison, “hard tone” was also used to clearly understand what encourages taxpayers the most to pay taxes on time. The World Bank used four different hard tone samples, including: deterrence, deterrence with an execution order attached, omission, and omission combined with deterrence together. These treatments explored the different effects of using a harsher tone. In the deterrence treatment, actions such as blocking bank accounts and salaries could be implemented as a punishment. Furthermore, payment of any execution expenses that arise must be covered by the non-complier. The deterrence with execution order treatment had the same contents as the deterrence letter however a sample execution order form was attracted to the letter. This evokes guilt and fear of the possible consequences of delayed payments. Taxpayers are illuminated to the harshness of the consequences. In an omission model the government chooses to see the non-payment of taxes as accidental and gives the benefit of the doubt to the defaulter. This method of framing is used to overcome status-quo

bias, which will be explored in detail later in this paper.

The effectiveness of the hard and soft-tone letters was compared in three parts: payment rate, payment amount, and outstanding tax liability. The payment rate is the percentage of the tax-paying population that pays their tax on time. The control group received an official enforcement letter called a dunning letter. Of this group, 40.2% made on-time tax payments. On average, the soft-tone letter increased payment rate to 43.8% while the hard-tone letter raised payments to 46.9% with p=0.01. This suggests that proper framing can increase payment rates and that overall hard tone is the most effective choice.

Additionally, the use of hard-tone and soft-tone letters increased the payment amount received per letter sent. In the control group, taxpayers paid on average 1,122.7 PLN (Polish Zloty), the soft-tone letters yielded 1278.0 PLN ($341 USD), while the hard-tone letters yielded 1368.3 PLN ($365 USD). The increase in payment received is significant as the total revenue collected increases greatly with the average payment. Lastly, the use of different tones reduced the overall tax liability. The dunning letter group had an average of 6.26% in tax liability, while behavioral letters had a tax liability of 6.17% for soft-tone and 6.10% for hard-tone letters. This shows that more people were filing their taxes and the number of short fillers was reduced giving the government valuable insight on the methods to use to increase tax compliance.

Lastly, this study delved deeper into how different taxpayers react to give a more insightful result. Letters reveal that taxpayers in their mid-40s are most responsive, with responsiveness decreasing afterwards. The hard-tone messages (omission commission + deterrence) perform best among those in their 50s, while softer messages reduce compliance, especially among older taxpayers. Younger taxpayers (20–29) respond positively to soft, public good messages, but these same messages have a negative impact on those aged 50–64, likely because older

taxpayers don't benefit directly from services like schools. The 5.2pp difference in response is statistically significant. Customizing messages by emphasizing relevant public goods for each age group could improve tax compliance. Both men and women’s highest paying rate from all the treatments was in the hard-tone treatment showing both genders respond more to the hard-tone letters. However, a difference emerges between parents and non-parent taxpayers. Parents were not very responsive to any of the treatments and the behavioral letter was the most effective. Conversely, all the hard-tone letters performed better than soft-tone and the behavioral letters showing hard-tone messages work on non- parents, but not on parents. Given these differences in effects across groups, a targeting system could be used to send out appropriate toned messages to increase tax compliance.

These studies concluded that hard-tone letters were the most effective in increasing tax compliance payments over outstanding debts. This does not negate that using soft-tone letters was also beneficial. The efficacy of these different tones depends on the individual characteristics of the taxpayer, such as age, gender, and parental status.

Complexities

Another major reason for tax noncompliance is the excessive use of legal jargon that impedes taxpayers’ understanding and ability to pay (Alm 2012, p.53). Fatigue and lethargy often influence an individual’s decision when a choice depends on a large amount of data as they are often unwilling to spend too much time or energy on that decision. Blumenthal and Slemrod (1992) found that, on average, taxpayers spent 27 hours recording and reporting their taxable activities. This leads people to employ heuristics such as intuition in decision-making.

Thaler and Sunstein (2008) found that humans have two systems for making decisions: an "automatic system" that quickly finds a solution and a "reflective system" that logically reasons out the problem. The use of intuition falls in the realm of “automatic systems.” Most of the time, the “automatic system” comes up with the same solutions as the reflective system, which uses logic, but sometimes it does not due to the usage of heuristics.

As mentioned earlier, the tax payment process has four steps: understanding, decision to pay, declaration, and payment. Complexities can be present in the “understanding” or “declaration” phase. Taxpayers have to individually compute the total value of taxes, a process which may be tedious due to inexperience or a lack of clarity regarding current tax laws. Additional problems arise during payment. Technology is constantly improving, thus, paying taxes has become much more simple. At times, too many options and related guidelines confuse and frustrate the taxpayer, causing them to abandon the process midway. Lastly, the complexity of the system makes the taxes seem unfair due to the lack of transparency in the income tax process which makes the taxpayer reluctant to pay their taxes on time or in full.

Economic models have customarily recognized three costs which might deter the take-up of tax benefits which are: the transaction costs of applying for a benefit, the costs of learning about eligibility and application rules, and lastly, the stigma associated with enrollment (Currie 2006). These concerns could be a consequence of confusion regarding program eligibility or incentives (e.g., Liebman and Zeckhauser 2004), inattention (e.g., Karlan et al. 2015), or psychological aversion to program complexity or the small “hassles” often involved in claiming (e.g., Bertrand, Mullainathan, and Shafir 2006). This reflects a failure of policy to deliver benefits to those who most need them.

As a case study, the United Kingdom released simplified letters to test whether they would increase tax compliance among dentists and doctors (Behavioural Insights Team, 2012). The simplified letters contained three short and easy-to-read sentences, outlining the actions and procedures required for compliance. This treatment saw a 15-30% higher response rate than other types of messaging, which shows that even highly skilled and well-educated people can be influenced to pay their taxes on time by simplifying the process. Furthermore, in Belgium, different methods were tested to overcome complexities in tax payment (Spinnewijn, Tsankova, and Luts, 2019). They simplified the tax letter by shortening the length of words, reducing the information overload, and highlighting the action-relevant information. This led to an increase in compliance by 10 percentage points (pp)(23% of the control mean). Moreover, late payers from the previous year were 2.6 pp more likely to file their taxes on time.

Complexities affect individuals in developed countries and underdeveloped countries similarly. Taxpayers in low and middle-income countries are also particularly adversely affected, due to lower literacy rates and a lack of trained accountants. This causes difficulty in accurately maintaining records, filing returns, and comprehending tax laws, resulting in partial filing, late filing or non-filing making them partial or non-compliant. This backs the findings of Gangl (Gangl et al., 2015b) where perceived fairness and legitimacy lead to deliberate trust in the tax authorities. By removing these complexities, taxpayers can understand how much they are paying and how it is calculated, building trust and improving compliance.

Complexities can lead to notable inefficiencies in government-run programs such as the Earned Income Tax Credit (EITC). Simplifying the tax system and reducing compliance burdens could increase benefit take-up, reduce

forgone benefits, and enhance revenue collection. The EITC, initially designed as an incentive for low-income individuals to work, demonstrates the barriers taxpayers face in claiming available benefits. Studies estimate a program take-up rate of 75% (Plueger 2009). A substantial portion of non-participation stems from informational barriers, with 16% of eligible individuals not filing taxes and 9% failing to claim the credit despite filing. This highlights the need for clarity in tax communication and simplification of claim procedures. Experimental evidence further underscores the sensitivity of benefit take-up to reduced informational complexity. Simplified notices, shorter worksheets, and enhanced salience of benefits through targeted messaging have demonstrably increased EITC claims, with a field study resulting in $4 million in claimed benefits out of $26 million identified as unclaimed (Manoli, 2015). Moreover, over-withholding demonstrates how simplifying processes can benefit both taxpayers and the government. Employers withholding excess taxes reduces taxpayers' need for year-end adjustments, leveraging loss-averse behavior to generate 42% more revenue than expected from interest costs alone. Simplification strategies can similarly mitigate tax manipulation, increase voluntary compliance, and maximize revenue efficiency.

Governments can reduce complexities in tax policy to increase the legitimacy and perceived fairness of tax administration. Simpler tax systems will increase compliance and reduce the opportunity for tax evasion and avoidance by making the steps of paying taxes easier and reducing the mental computation required of taxpayers.

III. Conformity

Conformity refers to individuals changing their beliefs, attitudes, behaviors, or

perceptions to complement the beliefs of a group to which they want to belong, and so they yield to group pressures (Crutchfield, 1955). Herbert C Kelman, an American psychologist, analyzed this behavior and distinguished three different forms of conformity: compliance, internalization, and identification (Kelman, 1958). For this paper, compliance and internalization are relevant. Compliance refers to “when an individual accepts influence [...] to gain specific rewards or approval and avoid specific punishment (Kelman, 1958, p. 53). This is a heuristic as many people become irrational and fall in without considering the benefits and drawbacks of their decision. According to an analysis (Zafar, 2011) people conform to groups because they are uncertain about their beliefs and believe that the group is more likely to be correct, a pattern denoted descriptive conformity. The second category is internalization which happens “when an individual accepts influence because the content of the induced behavior - the ideas and actions of which it is composed - is intrinsically rewarding. They adopt the induced behavior because it is congruent with their value system” (Kelman, 1958, p. 53) which is also considered injunctive conformity. In this form of conformity, the group’s beliefs become part of the individual’s belief system and the behavioral change is permanent. Examples of personal norms could include the individual desire to live a healthy lifestyle or help in social causes.

The World Bank tested conformity bias in Latvia where The informal economy was estimated at 20.3% of the GDP in 2016 (World Bank, 2019). The shadow economy refers to people who operate entirely outside the tax and regulatory system (US Treasury). The World Bank intervened by sending out tax letters which incorporate behavioral changes in this case social norms. These modified letters are called behavioral letters. There is a social norm to return favors where people feel obligated toward those who have done something for them. This is called reciprocity.

The social norms letter boosted timely tax filing compared to the control

group by 5% (3.2pp). Social norms messages also generated the maximum number of tax declaration submissions as compared to other methods like simple reminders and an omission/commission letter when given to non-compliers. This experiment further showed that the social norms messages had a greater impact on women than men as women responded to the messages by 3.0 pp more when compared to the control group. This coincides with the findings of Cross (Cross, 2017) where women are more likely than men to conform to social norms. The social norms letter even increased the average amount paid per taxpayer by $13.97 (210% increase from control group). The field experiment in Latvia concludes that using social norms improves tax punctuality and increases the payment amount.

In Poland, The World Bank tested the use of social norms (World Bank, 2017). The payment rate for the dunning letter was 40.2% while payment rates increased to 43.7%, the average payment amount increased from 1,123 PLN to 1,300 PLN, and outstanding liability was reduced from 6.26% to 6.17% where letters mentioning social norms were used. This experiment corroborates the findings of the Latvia experiment.

According to an OECD report (OECD, 2010) on small and medium-sized enterprises (SMEs), SME compliance is highly influenced by personal norms. Phrases such as “Doing the right thing,” “Because it is the law,” and “Presumption from Revenue that you have been honest,” are indicated as having a strong influence on compliance. Social norms affect these SMEs less compared to personal ones as the owner's personal norms may be more prominent. Personal norms are feelings of moral obligations to do “the right thing” (Schwartz & Howard, 1981). The owner can also easily implement changes based on their prioritized heuristics . Social norms may not play a crucial role in the taxpayer's mind as the owner would want to be unique compared to larger firms. Therefore

when the government tries to evoke conformity by using other firms as an example small businesses might not be encouraged to pay taxes. Responses related to personal norms are therefore stronger from a compliance perspective. Hence,it would be much more beneficial for the government to use personal norms on SMEs to improve tax compliance.

A field experiment in the UK (Behavioural Insights Team, 2012) examined the effect of various types of norms on taxpayers who had declared their income but had yet to pay their taxes. Three norm statements were used: “Nine out of ten people pay their tax on time” (basic norm); “Nine out of ten people in the UK pay their tax on time” (country norm); “Nine out of ten people in the UK pay their tax on time. You are currently in the very small minority of people who have not paid us yet” (minority norm).

Upon receiving the responses the economists learned that the basic norm statement produces a treatment effect of 1.3%, and the country norm statement produces a treatment effect of 2.1%. If these letters were sent to the entire tax-paying population there would be a £623,000 and £980,000 increase in total taxes paid within 23 days. In comparison, the minority norm statement had a much greater impact of 5.1%, which would represent a £2.367 million increase in taxes paid within 23 days. This underscores the highly effective method of using the conformity bias to improve tax payments.

A follow-up experiment was done to replicate the most effective treatment from the first experiment to increase credibility. The effect of descriptive (what others do) and injunctive (what others think should be done) norms were also compared. Results showed that reminder letters with the norm framings have a 7.1-7.8% effect on payment. Letters with norm statements motivate people to pay their taxes, especially when a minority norm frame is used. This boosts overall tax compliance. Moreover, when comparing descriptive

and injunctive, the data indicates that the descriptive treatment group has a 1.44% larger effect on payment than injunctive norms. Furthermore, this work reinforces wider evidence that descriptive norms are most effective when they can be targeted at a specific population or group, which in this case was achieved by referencing their local area. Applying successful messages throughout HMRC’s (UK's tax, payments, and customs authority) debt management practices led to £210 million being brought forward in the 2012/13 financial year alone. This would benefit the government greatly as they can use this revenue to provide subsidies and provide fiscal stimulus to the economy when needed.

By using social norms, taxpayers gain a sense of fairness, knowing that their neighbors and fellow citizens are held to the same standards. This creates transparency between the government and taxpayers. Taxpayers are more willing to file taxes on time when they have faith in their government (Jimenez, Iyer, 2016). To inform taxpayers and foster healthy personal norms, tax administrations may attempt to communicate messages that emphasize the significance of compliance. Engaging with young professionals can have an impact on their beliefs, which improves long-term tax compliance. Individuals are less likely to avoid their taxes if there is a sense that tax evasion is rare and the bulk of people are compliant. People frequently assume that disobedience is more common than it is. Therefore, dispelling misconceptions about the extent of evasion strengthens compliance and has a marginal cost for the policymaker. This increases tax compliance and reduces financial losses for the government.

IV. Status Quo

Status quo bias refers to the tendency to stick to one's current situation (Samuelson and Zeckhauser, 1998). Most decisions have a status-quo option and studies show that individuals tend to unjustifiably stick with the status quo

(Samuelson and Zeckhauser (1988); Anderson (2003)). People are often unwilling to change primarily because of the effort it takes to understand other available options or the lack of awareness about the alternatives. Christopher J. Anderson researched status quo bias and characterized this behavior as “conservation of energy” (Anderson, 2008) where humans do not decide unless a deadline is coming. In terms of income tax, this can be seen as taxpayers continuing to avoid paying taxes as they have already done so for an extended period. Not paying taxes has become the status quo of these taxpayers. Now there are many methods of filing taxes that are faster and more efficient, however, taxpayers seem to stick to the older methods. This could cause financial losses for the government as they don’t receive the full tax amount they are expected to collect. There also could be incomplete taking up of tax benefits such as Earned Income Tax Credit (EITC), Standard Deductions or Itemized Deductions in the USA when that is not their status quo. People tend to favor minimal changes and choose the default option (Kahneman, 1991). Even if there are better options, they will not change their actions or choices. Most real-world decisions have the status quo option. That is, do nothing and keep the current or previous state showing the significant influence default choices have on behavior.

The World Bank (World Bank Group, 2018; World Bank Group, 2019; World Bank Group, 2020), experimented with status-quo bias and its societal prevalence. They used a deliberate choice method to overcome the bias wherein non-compliance was considered a deliberate choice. This technique is intended to eliminate omission that serves as an excuse for non-compliance. Taxpayers unknowingly evade taxes by following the status quo. When they received letters they were made aware of their status quo so that lack of information can no longer be the reason for non-payment. Framing noncompliance as intentional minimizes uncertainty regarding inaction, heightens moral duties to take action and boosts the perception of deterrence.

For instance, the deliberate decision letter in Guatemala (World Bank Group, 2020) contributed to an increase of $17.95 (269% increase compared to no letter) in the average amount paid per taxpayer. Taxpayers in Guatemala who received the behavioral letters in the first year paid four times as much in taxes. Over time, these gains have been maintained. The intentional choice letter, when received, raises the average amount paid by $23.05, according to local average treatment effects (LATE). If this letter was sent to all the sampled tax-payers an estimate of US$757,837 of extra tax revenue could be generated in 11 weeks compared to when no letter was sent. This is over 35 times the cost of sending the letters highlighting the benefit to the government. The experiment with the status quo made use of framing as well. The phrase also exempts the taxpayer from failing to declare previously, which introduces a concept of reciprocity as the taxpayer is driven to feel he has been offered a favor. The wording suggests that the taxpayer's actions are being closely monitored, which heightens the feeling that noncompliance will result in penalties. In Guatemala, the deliberate choice letter, social norm letter, national pride letter, and behavioral letter were tested. Out of them, the deliberate choice letter was the most effective letter for improving declaration rates, boosting declarations by 5.4 pp (46% increase) compared to the control group. The average amount paid conditionally on payment grew by 38.5 percent, and the payment rate increased significantly by 1.4% points. Further, the average unconditional amount increased from US$6.70 the control group average to US$17.95 showing an increase of US$11.25 in tax revenue for each letter sent. The average cost of sending behavioral letters lowers as the rate of payment and payment amount increases.

Omission is the failure to fulfill a moral obligation, in this case, taxes. The World Bank used 3 different behavioral designs to overcome the status quo in Poland (World Bank Group, 2018), the treatments were "Omission + Deterrence", "Omission vs Commission" and "Omission Taxpayer-Perspective".

These letters all suggested that the government had given the taxpayers the benefit of the doubt, presuming that non-compliance had been due to oversight and not dishonesty. The letters inform the taxpayer about non-compliance and the potential consequences of non-compliance in the future

Upon analysis, it was found that the letter combining omission and deterrence messages was the most effective. It resulted in a 48.6% payment rate (8.37% increase) and increased taxpayer payments by 25.9%. The "omission + deterrence" letter also had the most significant reduction in outstanding tax liability, 19.3%. The use of only a deterrence message does not improve the standard behavioral letter as the standard behavioral letter had a payment rate of 46.3% compared to 44.8% for only deterrence. However, there is a significant gain when paired with the omission letter as payment rates jump from 44.8% to 48.6%. The other omission letters, which offer an excuse for noncompliance, do not yield a significant improvement in payment amounts over the standard behavioral message, despite increasing the compliance rate. The "omission + deterrence" letter was found to be the most effective out of the 3 categories of letter design and was always in the top 4 in increasing tax revenue. The omission letters also performed better overall than the behavioral letters suggesting that the omission message encourages payment mostly among tax- payers with a smaller liability; combining it with the threat (omission + deterrence) is very effective for taxpayers who owe more.

In Latvia (World Bank Group, 2019), an experiment using a simple reminder, a social norms letter, and an omission/commission treatment was done. The omission/commission treatment was found to be most effective in increasing compliance with taxpayer filing deadlines and the annual income statement (AID) process. It led to a 9.4% higher filing rate than the control group, a statistically significant improvement. It can be inferred that including social

norms is not as effective as using omission in improving tax compliance as the omission/commission treatment increases compliance with taxpayers following deadlines.

Another experiment in the UK (Behavioural Insights Team, 2012) related to reducing the cost or inconvenience of filling out forms to pay taxes was done. Initially, only a simple letter with details of the payment form attached, was sent which achieved a response rate of 19%. Subsequently, this letter was updated to include the tax timelines and a link to the online system as well as contact information in case of questions. This significantly reduced the effort of the taxpayers. The simplification of the process helped many taxpayers overcome the status quo as they could start the tax filing process by just clicking on the link. This resulted in an improved response rate to 23%. This reduction in work aligns with Anderson's research, which suggests that individuals tend to default to the status quo as a way of conserving energy. Online tax calculators could also be made more readily available so taxpayers can calculate the total tax they need to pay. This can help avoid delays due to dependence on tax accountants and overcome the status quo bias of relying on the accountant completely.

The benefits of simplification and digitalization are transferable over different aspects of a tax structure. In the USA taxpayers have two options to reduce their taxable income: standard deduction or itemized deduction. The standard deduction is a fixed amount that reduces taxable income without requiring documentation, while itemized deductions allow taxpayers to subtract specific expenses (e.g., medical costs, mortgage interest) if they exceed the standard deduction, though it requires detailed record-keeping and filing. Most taxpayers opt for the standard deduction due to its simplicity. This decision to itemize deductions versus claiming the standard deduction provides another lens into how complexity influences taxpayer behavior. While itemizing can result in

larger deductions, it imposes higher compliance costs, including meticulous record-keeping and additional forms. Revealed preference analysis suggests taxpayers perceive the burden of itemizing as equivalent to 19 hours of regular work or approximately $617, deterring many from pursuing this option (Benzarti, 2015). Consequently, two-thirds of taxpayers opt for the standard deduction, potentially leaving money on the table. This highlights another aspect of the tax system that is often overlooked by taxpayers and sticks with the status quo. If information was more readily available and digitalization of calculating deductions itemized income could be implemented, it could nudge taxpayers to choose the options with greatest savings.

Throughout the year, individuals make taxable income and make payments based on anticipated liabilities. On tax day, any discrepancy between total taxes owed and payments made is refunded, resulting in either a "loss" (balance due) or a "gain" (refund)(Jones, 2017). Kahneman and Tversky (1979) demonstrated that the perceived value of a marginal dollar declines sharply as a taxpayer moves from losses to gains. This loss aversion drives taxpayers facing a balance due to manipulate their liabilities more aggressively. Empirical analysis done by Jones of the 1979–90 IRS Statistics of Income Panel of Individual Returns, revealed significant shifts in the balance due distribution consistent with higher manipulation in the loss domain. Individuals facing a loss pursue an additional $34 of tax reductions above and beyond what would be pursued if they faced a gain. This highlights how taxpayers allocate more value to perceived losses and are more likely to change their behavior by changing their status quo to minimize their losses. This is particularly pronounced among high-income earners, underscoring how loss aversion exacerbates tax manipulation, ultimately depriving the government of revenues that would otherwise have been collected. It was estimated that if tax filers owning a payment were as motivated to

manipulate as those facing a refund, 1.4 billion dollars of additional tax revenue would be collected. Addressing this behavior by incentivizing over-withholding or reducing opportunities for manipulation could mitigate these losses and enhance revenue stability.

V. Possible tax policy

With the help of these field experiments, we realize that status quo, conformity, and framing biases play a pivotal role in tax revenue collection. These biases are often used by taxpayers to make their lives easier by doing what others do or sticking to their original choice. Governments should implement these behavioral findings into their current tax policies. By doing so, overall tax compliance from taxpayers would increase and cause less financial loss for the government as seen from the above case studies. They can successfully plan and fund projects and schemes that benefit the country's citizens. Below is a proposed framework outlining plausible policies and strategies that can be implemented to overcome the aforementioned biases.

The use of hard-tone language in tax letters, such as deterrence messages and execution letters, can increase tax compliance. Field experiments in Poland show that hard-tone letters were more successful in mobilizing payments and reducing tax debt compared to soft-tone letters. This method is particularly effective for older working age groups, who need a greater nudge. They have been paying taxes for a long period and have developed lethargy regarding this continuous and tedious process. Soft-tone letters were also found to be effective in improving compliance rates, but not as impactful as hard-tone. In most cases, only hard-tone should be used throughout the letter to make the need to pay taxes seem more urgent and prevent defaults.

However, to increase tax compliance overall, governments should use a

soft tone in letters to certain taxpayers based on their social identities. For example, hard-tone letters may not be effective with taxpayers who do not support the party in control. Soft-tone letters could also be used for younger taxpayers (ages 20-30) who may be more willing to comply with rules and regulations. Additionally, using a soft tone in letters to taxpayers with school-going children may be effective as they may be more willing to pay taxes to support the public education system. A hard-tone could be used for older taxpayers (50+) as they are more receptive to the hard-tone than the soft-tone. Moreover, the hard-tone can be implemented on non-parents as they need to be nudged more as they have lesser responsibilities (no children).

Simplifying the tax letter by removing legal jargon and providing clear steps to follow for tax paying will expedite the process and will increase tax revenue. This can overcome status quo bias and reduce the complexity of decision-making. Evidence from the UK and Belgium shows a positive correlation between clear and concise tax letters and compliance rates. Simplification also reduces the reliance on automatic systems and encourages timely payments from both late filers and payers.

The government can take advantage of the status quo bias by making tax deductions from employee salaries by the company the default choice. The company can pay the income tax collected directly to the government along with its corporate taxes. This is called an opt-in policy as the status quo is to opt in. Most employees would prefer to stay with the status quo as it reduces hassles for them. Another opt-in policy could be where the government directly estimates how much the employee has to pay. At the end of the financial year, the taxpayer can compare how much tax was estimated and collected by the government compared to how much they need to pay. This works on similar principles of advanced taxes where the employee estimates his payable tax amount and pays it

to the government quarterly. This solves the problem of how to pay taxes for the taxpayer as the government is doing it automatically for them and helps them overcome their status quo.

The use of social norms was also greatly experimented with in Latvia, Guatemala, Poland, and the UK. This underlines the importance of social norms in tax policies. It was found that personal norms hold a higher value than social norms in individuals and small and medium enterprises. Governments can use these findings to implement personal norms. These can be simple pieces of information regarding an individual's belief systems. Descriptive norms were found to be more impactful than injunctive norms in the UK. Governments should use personal norms when distributing tax letters to small-scale companies but use descriptive norms in the letters they send to individuals. Lastly, along with these norms described above the government can club it with a minority norm. This puts a spotlight on defaulting taxpayers who feel like they are not part of the desired group encouraging them to file their taxes. This will make the most efficient use of the conformity bias. Using a "worst offenders" list will also be effective as there would be a perceived social consequence to being on the list. People will increase their tax compliance so that they are not the exceptions. This phenomenon of feeling uncomfortable when not conforming is called the “spotlight effect” (Gilovich, 2000).

The Australian tax office's real-time analytics initiative sends customized prompts to taxpayers filing annual tax returns (OECD, 2021). For example, a taxpayer may see a pop-up notifying them that they have reported work-related expenses unusually high and prompting them to confirm their entries. The initiative prompted 25% of taxpayers to voluntarily amend their tax returns, generating approximately AUD$ 22.4 million in revenue from 2018 to 2019. This method can also be used so that tax filings are honest and accurate. Along with

these customized prompts,

Another small change that can be implemented to the tax filing website is subtle environmental cues such as smiling faces and a friendly telephone voice. These small nudges can stimulate cooperation among taxpayers and overcome the status quo of not paying taxes or partial payment of taxes. Similarly, this also implements a soft tone to gently nudge taxpayers to be honest with their tax fillings.

5.1 How does behavioral economics advance cost-effectiveness as opposed to traditional economics?

Behavioral interventions are extremely effective while having minimal additional costs as compared to the original tax letters. The average revenue collected is more than the average cost, hence highlighting that this method is extremely cost-effective for the government. The field study conducted in Guatemala (World Bank Group, 2020) helped increase revenue generated but at the same time was particularly cost-effective. It was estimated that the deliberate choice message would have generated revenues of USD 778,927 at a cost of $21,090 if sent to the entire sample of 43,387 taxpayers. This equates to 36 times the return on investment for tax authorities. It was estimated that $303,366 in revenue was generated and declared a profit of $288,301 for the Guatemalan Tax Authority showing it is beneficial to apply behavioral changes.

Moreover, since there are no statistically significant differences in delivery method outcomes, the option of sending reminders by regular mail can simplify execution procedures in Poland without affecting revenue collection. However, for tax payments, tax authorities can use existing technology, such as websites and smartphones, to facilitate compliance on a modest budget. In Kosovo (World Bank Group, 2019) emails and SMS messages were used to send

out behavioral tax letters instead of paper mail. This slightly reduces the overall costs resulting in increased tax revenue. The only major cost would be incurred while setting up the infrastructure. In years to come only small maintenance costs would be incurred making it a cost-effective solution in the long run.

The government can make these design changes to its tax policies and use these biases to its advantage and work towards effectively increasing its tax revenue. These changes are uncomplicated, cost-effective, easily implementable, and have achieved a positive impact worldwide. Hence it is the best possible solution available to limit the financial loss currently being sustained by the government due to non-payment of taxes.

VI. Conclusion

The World Bank Group has extensively researched how to successfully implement behavioral changes to tax policies. Behavioral changes are very helpful as they increase tax revenues and receiving correct tax amounts on time helps reduce financial losses for the government. They have run field experiments in various countries, like Guatemala, Poland, and Kosovo, and have found compelling evidence on how to nudge taxpayers to be more compliant. The 3 biases explored in this paper are only a few, many other biases and heuristics such as availability and loss aversion are present in the tax-paying process which also negatively affect the government. By using these behavioral interventions the government’s tax base would widen, resulting in lower tax rates and higher aggregate demand leading to a healthier economy in the long run. Paying taxes may not be enjoyable, but with the successful implementation of behavioral changes, it can be turned around. This research effectively exposes some of the reasons taxpayers are not very vigilant in paying taxes. If governments can successfully incorporate changes to their tax policies they can reduce the problem

of the tax gap and any financial losses.

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