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46 Harv. J. on Legis. 111 (2009)
Tax Penalties and Tax Compliance

handle is hein.journals/hjl46 and id is 113 raw text is: ARTICLE TAX PENALTIES AND TAX COMPLIANCE MICHAEL DoRAN* This Article examines the relationship between tax penalties and tax compliance. Conventional accounts, drawing from deterrence theory and norms theory, as- sume that the relationship is purely instrumental-that the function of tax penal- ties is solely to promote tax compliance. This Article identifies another aspect of the relationship that generally has been overlooked by the existing literature: the function of tax penalties in defining tax compliance. Tax penalties determine the standards of conduct that satisfy a taxpayer's obligations to the government; they distinguish compliant taxpayers from non-compliant taxpayers. This Article argues that tax compliance in a self-assessment system should require the tax- payer to report her tax liabilities only on the basis of legal positions that she reasonably and in good faith believes to be correct. But the accuracy penalties provided under current law set much lower standards of conduct. In the case of a non-abusive transaction, current law allows the taxpayer to base her self- assessment on a position having as little as a one-in-five chance in prevailing. For an abusive transaction, the taxpayer only needs a reasonable belief that her position is more likely than not to prevail. The Article describes reformed stan- dards of conduct for taxpayers, tax practitioners, and government officials that define tax compliance more appropriately for a self-assessment system. I. INTRODUCTION Why does government impose penalties on those who do not pay taxes? Taxation, however legitimate, constitutes a forced extraction of wealth: why then does government extract one amount from those who pay in the first instance but a larger amount from those who do not? The conventional an- swer is that a penalty promotes compliance. But even if one reasonably takes it as given that government wants taxpayers to comply with their tax obliga- tions, this simply raises the further question why government would expect tax penalties to promote compliance. After all, if a taxpayer does not comply with an obligation to pay a tax, it is not immediately obvious that the impo- sition of a tax penalty-in effect, a second tax-will cause her to pay both the tax and the penalty. The justification for tax penalties would appear to turn on what moti- vates taxpayers to comply with their tax obligations. The existing literature presents competing models in response to that question. The standard deter- * Associate Professor, University of Virginia School of Law. B.A., Wesleyan University, 1988; J.D., Yale Law School, 1991. For helpful discussions and comments on earlier drafts, many thanks to Bill Gentry, Michael Graetz, Mitchell Kane, Alex Raskolnikov, Chris Rizek, Jim Ryan, Michael Schler, Dan Shaviro, Paul Stephan, Jack Townsend, Dennis Ventry, Rip Verkerke, Ethan Yale, George Yin, and the student participants in the 2008 Columbia Law School Tax Policy Colloquium. Kelli Schied and Khang Tran provided excellent research assistance.

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