An experiment using "nudge" letters to coax Canadians in the underground economy to pay their taxes has flopped, highlighting the limits of this new approach to changing citizen behaviour.

"Nudge" economics is the practice of encouraging people to make desired choices through suggestion rather than by threat of penalty or sanction.

The approach has been enthusiastically adopted by the British government, which in 2010 created a special unit to try "nudge" techniques on the population, including for tax collection. Australia, the United States, France, Switzerland and others have followed suit.

An example of the March 11, 2016, 'nudge' letters directed at Canadians believed to be working in the underground economy. (Dean Beeby, CBC Ottawa)

The Canada Revenue Agency has been a recent convert, experimenting with low-cost "nudge" techniques in various tax-collection initiatives since 2014.

But the agency hit a wall last year when an underground-economy experiment involving 6,877 taxpayers failed, apparently demonstrating that hard core tax evaders pay scant attention to soft-sell letters from the taxman.

Last year's experiment focused on taxpayers in the underground economy, which traditionally includes home renovators, food service employees and others in sectors where cash transactions are common. The report released to CBC News blacks out exactly which underground economy players were targeted, and the CRA declined to identify them when asked directly by CBC.

"In conclusion, we failed to find evidence supporting any of the three behavioural outcomes that the nudge campaign expected to produce," says an internal August 2016 report, obtained by CBC News under the Access to Information Act.

Each of the three desired outcomes that failed to transpire involved a taxpayer acknowledging income that previously may have been deliberately hidden from the Canada Revenue Agency.

The agency carried out one of its first "nudge" experiments in September 2014 on 8,000 ordinary taxpayers who had been assessed up to $950 in taxes owing for the 2013 tax year but had not yet paid.

"Nudge" letters – half of them with friendly encouragement, the other half with less-friendly language — were sent to these taxpayers, and compared with those who got a standard stern collection letter.

The agency found that the "nudge" letters collected 12 per cent more taxes owed than the standard letter.

Behaviour compared

Letters were sent in March 2016. One group received a version with a positive message: "You can benefit by reporting all your income." Another group got a version with a negative tone: "Avoid costly consequences by reporting all your income."

The behaviour of the letter recipients was compared with that of people in a control group, who did not receive a letter. Each version of the "nudge" letter had a special CRA website address, to help the agency determine whether one or the other letter – friendly versus unfriendly – generated more web traffic.

Overall, I am unsurprised by the findings - Economist Lindsay Tedds, on the disappointing results of CRA's "nudge" experiment in 2016.

The websites did see some traffic spikes, but the letters had no effect on "nudging" these taxpayers to report more of their income. Unexpectedly, the control group – the underground-economy targets who received no "nudge" letters – actually reported more new income than the "nudged" groups.

"Nudge" economics has been criticized by some experts as a flash in the plan – as taxpayers become accustomed to friendly reminders, they ignore them more. In some jurisdictions, such as France and Switzerland, even initial "nudge" letters had no effect.

The approach has also been deemed inappropriate for some classes of taxpayers, including those with hardened attitudes against paying their taxes.

Called inappropriate

A July 2014 workshop run by the CRA itself found nudging "unsuitable" for people with "strong negative attitudes toward the CRA or taxation in general; low risk aversion; lack of concern with consequences of getting caught; perception that cheating on taxes is 'not a big deal'."

A university economist specializing in taxation who made a presentation at the 2014 workshop says she warned CRA that "nudge" techniques are inappropriate for underground-economy players.

"Overall, I am unsurprised by the findings," Lindsay Tedds, an associate professor in the School of Public Administration at the University of Victoria, said of the 2016 experiment.

"CRA should be unsurprised by the findings. Nudge is not the tool to be using for intentional tax non-compliance."

Rather, the technique "will work on people who made a mistake, don't understand the rule, lack information, follow the herd, misunderstand the risks, and so on," Tedds has written.

A spokesman for the CRA, David Walters, acknowledges the experiment did not produce the expected outcome.

University of Victoria Prof. Lindsay Tedds advised the CRA in 2014 that players in the underground economy were not suitable targets for "nudge" letters. (University of Victoria) "Although the results of this particular experiment suggest that nudge messaging may not be the most effective approach to influence the reporting behaviour of underground economy (UE) participants in the particular industry sector chosen for the 2016 experiment, there may be other UE participants for who such techniques could prove effective," he said.

"Even if a nudge does not produce the intended result, the CRA still learns valuable information about the behaviour of the targeted information."

The cost of the 2016 experiment, like many "nudge" initiatives, was low at $17,400.

Last year, Statistics Canada released a report estimating the size of Canada's underground economy in 2013 at $45.6 billion.

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