Do nudging letters play a role in contrasting tax evasion?

Abstract This study presents a theoretical sequential game for exploring a two-stage audit strategy implemented by the State to combat tax evasion. The players are the entrepreneurs and the tax inspectors who act on behalf of the State. Specifically, the model introduces the so-called “nudging letters”, which represent a preliminary step in the audit process for “gently” pushing entrepreneurs to pay taxes before a formal inspection. It is shown that the nudging activity interacts with business cycle, taxation, bargaining power of the entrepreneurs, and audit policy. In detail, the results suggest that nudging letters strengthen the deterrence effect of monitoring activity through an increase in perceived reputational costs of evading. Moreover, monitoring activity is more effective in the presence of low tax rates.