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Determining Effectiveness and Taxpayer Perception
Tax professionals are aware of the arsenal of tax penalties available to the IRS. Taxpayers often become aware of tax penalties only when faced with a notice from the IRS, resulting from an examination, the late filing of a return, or the late payment of a tax. Yet penalties are assumed to act as deterrents. The deterrent effect of tax penalties can be questioned from five distinct perspectives. The first involves the much-discussed complexity of the tax code and its effect on deterrence. The second is the IRS's penalty abatement policy, which, in some instances, results in more penalty dollars being abated than collected. The third is the economic model of rationality supporting tax penalties, which assumes taxpayers rationally weigh their odds of detection and the probable economic cost in penalties and additional tax dollars when deciding their level of compliance. The fourth is the practical matter that, in order for penalties to effectively deter noncompliance, they must be known and understood and taxpayers must see that others are being caught and penalized. The fifth relates to how the relative amount of penalties is determined.
Although penalties raise revenue, they are also sanctions assumed to act as deterrents, and their deterrent effect has been the subject of study. According to Michael Saltzman, "Sanctions for noncompliance ... are forms of retribution, of varying degrees of severity ranging from small fines to heavy prison sentences, the threat of which contributes to maintaining compliance with the revenue laws at high levels" (IRS Practice and Procedure, Warren, Gorham & Larnont, 1981). In Spies v. United States, the Supreme Court emphasized the importance of tax penalties:
The United States has relied for the collection of its income tax largely upon the taxpayer's own disclosures. . . . This system can function successfully only if those within and near taxable income keep and render true accounts. In many ways, taxpayers' neglect or deceit may prejudice the orderly and punctual administration of the system as well as revenues themselves. Congress has imposed a variety of sanctions for the protection of the system and the revenue (317 US 49F495, 1943).
It is thus the self-assessment model, or the voluntary nature of our tax system, that necessitates the...