Behavioral economics taps power of persuasion for tax compliance Mon Oct 29, 2012 6:02am EDT (Reuters) - Can peer pressure make delinquent taxpayers pony up what they owe the government? Behavioral economists say it can, and some tax agencies in both the United States and Britain are taking their advice to heart -- and finding that they are reaping rewards. Behavioral economics has already upended investing and finance with new theories on why and how people make decisions about their money. From the simple re-wording of late notices to changing the structure of back-tax payment plans, tax collectors are getting results by tapping into basic human tendencies. Whether it is the desire to do what peers do or to stick with a voluntary commitment, persistent patterns of human conduct revealed by behavioral economics are gradually being targeted to boost tax revenues at very low cost. "People forget the basis of our system is voluntary compliance," said Ted London, a California-based specialist in taxation with information technology consultancy CGI Group Inc. The vast majority of people want to do the right thing. If government can make it easier to understand what that is, it can have a big impact," he said. Behavioral economists study how social and emotional factors influence economic decisions, using psychology and other disciplines to shed light on how and why we behave as we do when it comes to finance and money. These researchers' insights have undermined orthodox economic theories that assume consumers and investors make decisions based solely on material self-interest. Tax administrators traditionally have focused on penalties to compel compliance. That remains important, but audits and legal enforcement action are expensive. Behavioral strategies can help do the job at far lower cost, experts said. Psychologist Robert Cialdini, a professor at Arizona State University and an expert in persuasion, pioneered the social insight that if people know what their peers are doing, they are more likely to do the same. Applying that insight, the British tax agency, Her Majesty's Revenue and Customs (HMRC), has tested different form letters on delinquent taxpayers. In one letter, this sentence - "Nine out of 10 people in the UK pay their tax on time" - increased positive response by 1.5 percent. Adding another sentence - "You are one of the few who have not paid us yet" - raised the success rate 3.9 percent. HMRC also found compliance rose 6.8 percent when taxpayers were told they were one of few delinquents in their hometowns. The HMRC's work is led by its Behavioral Insights Team, which is advised by University of Chicago professor Richard Thaler, a founder of the field of behavioral finance. Other tax administrators have caught on to these ideas on their own, without a behavioral economist to guide them. A push for "plain English" in tax forms over the past decade has led the Washington State Department of Revenue toward behavioral ideas of salience, the idea that people focus only on what they understand. After re-writing the department's form letter sent to firms believed to owe tax on the use of goods or services, positive responses from taxpayers increased 43 percent. Washington State's first-ever tax amnesty program was also written by experts in plain language. It recently generated $321 million in new tax revenue for the state. The results have made the department receptive to the idea of more targeted messages like HMRC's, said Janet Shimabukuro, assistant director of Washington's Taxpayer Services Division. Structuring late payments is another area where understanding behavior can have an impact. After employers began structuring 401 (k) plans in a way that required employees to opt out, rather than opt in, participation in the plans jumped. Behavioral scientists call this default, or the idea that people are less likely to stop doing something than they are to fail to start doing it in the first place. California saw a similar result some years ago when the state started requiring tax payment plans be structured as electronic bank account withdrawals. Though taxpayers could cancel, they tended not to. Missed payments are now only 5 percent, according to the California Franchise Tax Board. That is on 200,000 installment agreements. Last year, the state received over $363 million in installment payments. Reporting by Nanette Byrnes; Editing by Kevin Drawbaugh and Leslie Adler