By BVR Subrahmanyam & PS Puniha
Behavioural science, an insightful combination of psychology, economics, and linguistics, can improve tax conformity. Traditionally, the tax codes assume individuals to be rational and guided solely by self-interest. In contrast, behavioural science recognises that human conduct and actions often deviate from rationality due to cognitive biases, social influences, and emotional factors. Accounting for these values and conduct moderators in tax laws, regulations, and interactions among taxpayers and administrators may increase voluntary compliance—the ultimate desired goal of tax administration.
Elevated tax law observance is crucial for any nation to collect sufficient revenues for public services, infrastructure, and social programmes. Easily understandable and clearly communicated options and their individual as well as social costs and benefits may motivate taxpayers to comply with tax laws in letter and spirit. Nobel laureate economist Richard Thaler clearly articulates this core theme of behavioural science: “The framing of a decision can significantly influence its outcome, highlighting the importance of presentation. Nudges can be effective tools to help people make better decisions without restricting their choices.” For instance, if taxpayers are repeatedly informed that a certain percentage of their tax payments support public goods like education and healthcare, they may be more inclined to comply with tax laws. European Union countries have often employed this framing strategy to enhance tax compliance through a commitment to civic duties of citizens. While launching the innovative and pioneering faceless direct tax administration scheme in August 2020, India’s Prime Minister praised the role of honest taxpayers in nation-building. He outlined the path to make tax administration seamless and painless, and desired that the state must honour honest taxpayers, observing, “When the life of an honest taxpayer of the country becomes easy, he moves forward and develops, then the country also develops and leaps forward.” The conception of nation as more of a cultural entity, and not a mere political unit, in the Indian tradition underlies his emphasis on state honouring individuals who contribute to national development.
Simplifying and personalising tax communication
The Organisation for Economic Cooperation and Development’s (OECD) 2020 report on tax administration highlights that conventional tax policies often overlook the psychological and social dimensions influencing taxpayer behaviour. It suggests that small changes in the way tax information is presented, timing of communications, and simplification of processes may have positive influence. As an illustration, framing the reminders that emphasise social norms, such as indicating “most people in your area have already paid their taxes”, encourages procrastinators to settle their obligations promptly. The OECD report also observes that complex tax systems can deter compliance due to the cognitive overload. By simplifying the language, structure, and process of filing tax returns, administrations may reduce such barriers for taxpayers. An ease of compliance and streamlined experience enhances compliance by addressing behavioural tendencies where individuals may avoid tasks perceived as too complicated or time-consuming. This recommendation is in line with the behavioural science concept that ease of action influences decision-making. Similarly, the International Monetary Fund (IMF) suggests that sending personalised reminders to taxpayers via emails or text messages about deadlines may significantly improve compliance rates. For example, notifications that remind individuals of their specific due dates and amounts can prompt timely action. The IMF guidelines also recommend communicating to taxpayers the percentage of peers who comply with tax obligations. For instance, informing taxpayers that “85% of your neighbours have already paid their taxes” can leverage social norms to encourage others to follow suit, as individuals often align their behaviour with that of their peers.
Culture, morality, and loss aversion
Behavioural science posits that people are more sensitive to losses than gains. Nobel laureate psychologist Daniel Kahneman summarises, “Losses loom larger than gains. An investment said to have an 80% chance of success sounds far more attractive than one with a 20% chance of failure.” Tax compliance programmes that highlight potential losses through penalties or loss of financial benefits rather than just the gains from compliance can leverage this bias. It implies that revenue authorities need to focus on enforcement of any delays and defaults in tax payment and they ought to take penal action without any deference or discretion in cases of wilful delays and defaults. Consistent action and communication on these lines may strongly deter non-compliance. The Australian Taxation Office has implemented a range of such behavioural insights’ initiatives, including using reminder letters that emphasise the broader community benefits of tax compliance as well as the potential losses associated with any wilful non-compliance.
Those who design and implement policy should acknowledge the challenges in applying behavioural science to improve tax compliance. Nations have unique cultural contexts that affect the effectiveness of behavioural strategies. Policymakers need to consider cultural and social values and develop strategies that foster trust and responsiveness among taxpayers in their efforts to improve compliance rates and a fairer tax system. The four objectives of human life in Indian cultural tradition that extend beyond immediate financial gain to include dharma (righteousness), artha (prosperity), kama (pleasure), and moksha (self-actualisation) suggest a unique combination of life goals of material abundance and self-actualisation among the majority of Indians. It also reflects a deeper impact of local community interactions. A logical corollary of such individual and community conduct may call for tax policies that facilitate entrepreneurship and create a conducive environment for business growth through start-ups, small and medium enterprises, and innovation. It may also suggest a higher emphasis on moral responsibility and ethical behaviour in designing tax compliance messages and communications. These cultural values and community interactions may also require more attention on educational campaigns that highlight the importance of paying taxes as a civic duty and a moral obligation. Policymakers also need to be aware of the complexity of assessing the effectiveness of behavioural interventions to increase compliance. It may need robust evaluation frameworks to determine the actual benefits of non-material incentives as well as clearly articulated costs of non-compliance for increasing voluntary compliance of tax laws and to achieve higher tax revenues.
To sum up, leveraging the many facets of human behaviour and actions through behavioural science tools may help policymakers align tax systems with the ground realities of taxpayers’ psychology and conduct. Appreciation of cultural nuances, cognitive biases, and emotional decision-making of taxpayers that is articulated in localised data and evidence is likely to lead to a more stable and equitable tax policy as well as compliance solutions.
The writers are respectively CEO and fellow, NITI Aayog.
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