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Abstract:
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We use Hidden Semi-Markov Models to extend a 2016 study on persistence of the compliance impact for tax examinations of Employee Business Expense (EBE). Using panels of yearly returns for taxpayers reporting EBE, we compare future filing behavior of those audited and those not audited, by fitting and comparing Hidden Semi-Markov Models for both groups. The Markov state space is EBE reporting compliance. The observed emission vectors are functions of items reported on a series of annual returns filed after a baseline year, which is the year of the tax audit for those who were audited. The functions used to create the observation vectors are proxies for compliance, and the unobserved Markov state space is true compliance. Using Semi-Markov Models allows us to relax the Markov assumption that current year reporting compliance depends on just one prior year's compliance. We will fit Hidden Semi-Markov Models that extend the dependence to two, three and four prior years.
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