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Winning The Audit Lottery

Publication Date: 
November 30, 2009
Ian Ayres and Barry Nalebuff

Professor Joseph Bankman, an expert in taxation law, is quoted in this Forbes article on audit compensation:

The chance your tax return will be audited is 2 in 1,000--and we think that's far too low. Really. In 2008 the average field exam of an individual return generated $19,000 in additional taxes. Even if incremental audits were only half as productive, doubling the rate would bring in another $3 billion in revenue. Higher audit rates would also indirectly generate revenue by motivating taxpayers to be more honest. Lots more honest. Jeff Dubin at Caltech estimates that an additional dollar directed toward audits would return $58 through higher compliance.

To make matters worse, we're relying on outdated data in deciding whom to audit. Every three years until 1988 the IRS randomly selected 100,000 returns for nasty, intrusive reviews, the purpose being not so much to squeeze every last penny from those unfortunates as to find out where the chiseling was going on. These extreme audits provided the IRS with statistical profiles of noncompliance that formed the basis for the agency's formulas used to target returns with the highest chance of underreporting.


Pay people for being audited--say, $3,000 for the extreme audit. Stanford tax guru Joseph Bankman notes that this sum would overcompensate almost all taxpayers; someone getting that much for 40 hours of trouble would be getting $75 an hour. To be sure, the richest taxpayers and people with the most complicated returns would be only partially compensated, and the money wouldn't necessarily cover the fee of a tax attorney or accountant. But $3,000 of compensation would go a long way in reducing the public opposition to auditing.