Do Small Businesses Respond to an Increase in the Probability of a Tax Audit? Evidence from a Policy Reform in Italy

This paper uses a panel of administrative data concerning 71,000 Italian small businesses observed in tax years 2005-2008. The aim of the paper is to evaluate the impact of a reform of audit rules implemented in 2006. The reform repealed a special audit exemption previously granted to businesses which adopted a stringent accounting standard. It is shown that the reform increased the level of economic activity, as measured by the value of inventory, for the generality of businesses involved. However, an increase in profits and turnover was reported only by the subset of businesses which were more likely to perceive it as an increase in the probability of an audit. This result is in line with the predictions of the Allingham-Sandmo model and it casts some doubts on the possibility to reduce evasion by limiting the opportunities of manipulating accounting books