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Tax Compliance and Rank Dependent Expected Utility

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  • Jean-Louis Arcand

    (CERDI-CNRS, Universit� d'Auvergne, and European Union Development Network, France)

  • Gr�goire Rota Graziosi

    (CERDI-CNRS, Universit� d'Auvergne, 65 bd Fran�ois Mitterrand, France, e-mail: gregoire.rota_graziosi@u-clermont1.fr)

Abstract

Formulating the classic Allingham and Sandmo [1972] tax compliance problem under Rank Dependent Expected Utility (RDEU) provides a simple explanation for the “excess” level of full compliance observed in empirical studies, which standard Expected Utility (EU) theory is unable to explain. RDEU provides a compelling answer to this puzzle, without the need for the moral sentiments or stigma arguments that have recently been advanced in the literature. Formally, we show that the threshold audit probability or penalty rate at which full compliance becomes optimal for the decisionmaker are significantly lower under RDEU axiomatics than in the EU case, and that the optimal level of underreporting is lower under RDEU. Numerical simulations using various parameterizations of the probability weighting function illustrate the large quantitative differences between the two models, while a simulation of underreporting rates in the US over the past 50 years shows how RDEU can go some way towards explaining the tax-compliance puzzle. The Geneva Risk and Insurance Review (2005) 30, 57–69. doi:10.1007/s10836-005-1108-1

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Bibliographic Info

Article provided by Palgrave Macmillan in its journal The Geneva Risk and Insurance Review.

Volume (Year): 30 (2005)
Issue (Month): 1 (June)
Pages: 57-69

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Handle: RePEc:pal:genrir:v:30:y:2005:i:1:p:57-69

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  1. Eduardo Engel & James Hines, 2000. "Understanding Tax Evasion Dynamics," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 1117, Econometric Society.
  2. Diecidue, E. & Wakker, P.P., 2000. "On the Intuition of Rank-Dependent Utility," Discussion Paper, Tilburg University, Center for Economic Research 2000-74, Tilburg University, Center for Economic Research.
  3. Uzi Segal & Avia Spivak, 1988. "First Order Versus Second Order Risk Aversion," UCLA Economics Working Papers, UCLA Department of Economics 540, UCLA Department of Economics.
  4. Koskela, Erkki, 1983. "A note on progression, penalty schemes and tax evasion," Journal of Public Economics, Elsevier, Elsevier, vol. 22(1), pages 127-133, October.
  5. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  6. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, Springer, vol. 5(4), pages 297-323, October.
  7. Ronald G. Cummings & Jorge Martinez-Vazquez & Michael McKee, 2001. "Cross Cultural Comparisions of Tax Compliance Behavior," International Center for Public Policy Working Paper Series, at AYSPS, GSU, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University paper0103, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
  8. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, Econometric Society, vol. 66(3), pages 497-528, May.
  9. Allingham, Michael G. & Sandmo, Agnar, 1972. "Income tax evasion: a theoretical analysis," Journal of Public Economics, Elsevier, Elsevier, vol. 1(3-4), pages 323-338, November.
  10. Bernasconi, Michele, 1998. "Tax evasion and orders of risk aversion," Journal of Public Economics, Elsevier, Elsevier, vol. 67(1), pages 123-134, January.
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Cited by:
  1. Philipp Meyer-Brauns, 2014. "Optimal Auditing with Heterogeneous Audit Perceptions," Working Papers, Max Planck Institute for Tax Law and Public Finance tax-mpg-rps-2014-06, Max Planck Institute for Tax Law and Public Finance.
  2. Hashimzade, Nigar & Myles, Gareth D. & Page, Frank & Rablen, Matthew D., 2014. "Social networks and occupational choice: The endogenous formation of attitudes and beliefs about tax compliance," Journal of Economic Psychology, Elsevier, Elsevier, vol. 40(C), pages 134-146.

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