JATA - Fall 1994

Volume 16, No. 2

Transfer Efficiency and the Trickle-Up
Phenomenon in the Market for
Small-Issue Private Activity Bonds

Janet A. Meade and Stanley Y. Chang


Critics of the tax exemption on private activity bonds (PABs) contend, among other things, that the tax-favored status of these bonds distorts the overall tax-exempt bond market. In so doing, the exemption increases both the inefficiency of the federal revenue transfer to the issuing states or localities and the rate at which the tax advantage associated with the exemption "trickles-up" to bond purchasers in higher tax brackets. This study examines the effect of federal tax policies enacted during the 1980s on the transfer efficiencies and trickle-up yields of samples of small-issue PABs and general obligation bonds issued between 1980 and 1990. The results indicate that the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), the Deficit Reduction Act of 1984 (DRA), and the Tax Reform Act of 1986 (TRA) significantly increased the transfer efficiencies of the bonds while simultaneously reducing the trickle-up yields. Additionally, the results show that these Acts differentially affected the transfer efficiencies and trickle-up yields of the two samples. One implication of these findings, therefore, is that TEFRA, DRA, and TRA restored much of the federal subsidy associated with tax-exempt bonds to the issuing state or local governments.

The Effect of Taxes on Switching Stock Option Plans:
Evidence from the Tax Reform Act of 1969

Silvia A. Madeo and Thomas C. Omer


In the early 1970s many firms replaced their qualified stock option plans with non-qualified plans. Although tax and incentive reasons for the switch probably interacted, previous research suggests that tax reasons dominated incentive reasons. This paper presents evidence that previous research concerning switches to non-qualified stock options following passage of the Tax Reform Act of 1969 may have overstated the effect of taxes on plan switches by failing to control for non-tax factors such as firm size and management ownership of stock. Specifically, the evidence presented here indicates that taxes were not the dominant factor behind the switches. Instead, option plan switches during the transition period from 1969 through 1971 occurred more often in poorly performing firms that were larger and had low management ownership of stock. After 1971, when the tax rate changes associated with the 1969 Act were fully phased in, firms with low asset-based tax shields and low management ownership of stock were more likely to switch.

An Evaluation of the Revenue and Equity
Effects of Converting Exemptions
and Itemized Deductions to a Single
Non-Refundable Credit

Suzanne Luttman and Roxanne Spindle


Individual taxpayer data is used to analyze a proposal to replace all itemized deductions, exemptions, and the standard deduction with a 15 percent non-refundable credit. Three models are initially evaluated: a simple credit model, a revenue-neutral credit model, and a revenue-generating credit model. These are compared to the current system of deductions, which interacts with a progressive tax structure to maximize benefits for taxpayers with the highest marginal tax rates. Recent tax law changes indicate that Congress intends to limit the benefit of deductions for wealthy taxpayers in order to generate revenue and eliminate the perception of inequity. It is the contention of this paper that this can be done more effectively through a credit mechanism than through the current system of deductions.

Self-Audits, Penalties,
and Taxpayer Compliance

Thomas Hemmer, Christopher H. Stinson,
and Igor Vaysman


This study investigates the introduction of self-conducted audits ("self-audits") into a reporting and auditing game between taxpayers and a taxing authority. When taxpayers are not expecting self-audits and when the number of audits is limited by budget constraints, penalty-free self-audits can increase taxpayer compliance when the cost of self-audits is sufficiently low. However, when taxpayers are expecting the possibility of penalty-free self-audits, compliance can be lower than it would have been without self-audits. Therefore, early "test-marketing" of penalty-free self-audits may indicate that they increase taxpayer compliance, while subsequent establishment of penalty-free self-audits can result in decreased compliance.

Nonetheless, self-audits (with penalties) can be desirable additions to a taxing authority's tax-collection technology. If the cost of a self-audit is sufficiently small (relative to regular audits), the introduction of self-audits can increase taxpayer compliance when taxpayers are anticipating a reporting and auditing game that includes self-audits. If the proportion of truthful taxpayers is sufficiently large (when only regular audits are used), self-audits with penalties yield higher compliance than do penalty-free audits.

Factors Associated With Noncompliance:
Evidence from the Michigan Tax Amnesty Program

James C. Young


Using data collected from individual tax amnesty participants in Michigan, I perform a series of regression analyses to identify factors associated with Michigan amnesty participation and compare these factors with findings from previous taxpayer compliance research. Analysis of amnesty participants provides the unique opportunity to examine previous nonfilers and underreporters (although amnesty participants are a subset of all noncompliant taxpayers). Separate regressions were run on the entire data set, five income stratifications of the entire data set (based on adjusted gross income), and a data base created to examine taxpayers who were likely unknown to the Michigan Treasury Department prior to amnesty.

Subject to the confines of the data, this study suggests that noncompliance increases as income increases. Specifically, amnesty participants with twice as much adjusted gross income relative to other amnesty participants had about 51 percent more unreported income. In addition, taxpayers having some form of Treasury Department contact prior to amnesty (either directly or by information submitted to the Treasury Department) had 93 percent less unreported income than those amnesty participants who had no prior contact. Amnesty participants with the most opportunity to evade taxes (a composite of occupation, income level, and access to cash income sources) had 84 percent more unreported income than other taxpayers. Finally, increased noncompliance was associated with (1) sales or self-employed occupations, (2) returns prepared by practitioners, (3) geographic location of the taxpayers, (4) single males, and (5) family size.

Legislative Justification and the Perceived
Fairness of Tax Law Changes: A Referent
Cognitions Theory Approach

Martha L. Wartick


This study uses a referent cognitions theory framework to investigate whether providing taxpayers with the legislative reason for a tax law change that limits or repeals a tax preference affects their perceptions of its perceived fairness. The theory predicts that taxpayers made worse off by the change will perceive the change to be more unfair than those not affected. More important from a policy perspective, the theory also predicts that fairness perceptions can be influenced by providing a reason for the change. Both predictions were tested in two experiments using experienced taxpayers as subjects. In both experiments, the legislative reason for a change was either provided to the subjects or not provided. The results of the study support the hypothesis that taxpayers who perceive that they were made worse off because of a tax law change perceive the change to be less fair than taxpayers who do not perceive that they were made worse off. In addition, the study provides evidence that providing affected taxpayers with this information mitigates their perception that the tax law change in unfair. The results of this study suggest that this may be a practical way to lessen taxpayers' potential negative reactions to tax increases.

An Experimental Examination of Factors
Affecting Tax Preparers' Aggressiveness--
A Prospect Theory Approach

Dan L. Schisler


Duncan et al. (1989) and Pei et al. (1992) provide evidence indicating tax preparers tend to communicate pro-IRS responses to aggressive clients. The purpose of this study is to re-address the aggressive client issue employing tax scenarios that are not explicit "red flags" to the IRS. The client's payment status is also incorporated. Kahneman and Tversky's (1979) prospect theory is used to predict the preparers' behavior. The sample consisted of 119 experienced tax preparers who were required to make recommendations on tax positions and determine whether or not they would include the deductions on a return.

The findings indicated tax preparers are not affected by the client's payment status until exposed to the client's preference concerning a specific tax position. With an aggressive client, tax preparers were significantly more aggressive concerning tax issues. The aggressiveness was compounded by the client's payment status. Aggressive positions were highly accepted by preparers with aggressive clients in tax due situations. These results are contrary to Duncan et al. And Pei et al. Overall, these finding indicate tax preparers behave according to prospect theory when placed in a position of opposing the client.