Why Do People Pay Taxes? An Explanation Based On Loss Aversion And Overweighting of Low Probabilities
AbstractGiven actual probabilities of audit and penalty rates observed in the real world, tax evasion should be an extremely attractive gamble to an expected utility maximizer. However, in practice, one observes too much compliance relative to the predictions of expected utility. This paper considers an alternative theoretical model that is based on Kahneman and Tversky's cumulative prospect theory. The model predicts empirically plausible magnitudes of tax evasion despite low audit probabilities and penalty rates. An increase in the tax rate leads to an increase in the amount evaded- a result, which is both, intuitive, and factual, but is contrary to the prediction made by expected utility theory. Furthermore, the optimal tax rates predicted by prospect theory, in the presence of tax evasion behaviour, are consistent with actual tax rates.
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Bibliographic InfoPaper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 03/18.
Date of creation: Dec 2003
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Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
- H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion
- K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-02-01 (All new papers)
- NEP-LAB-2004-02-01 (Labour Economics)
- NEP-LAW-2004-02-01 (Law & Economics)
- NEP-MIC-2004-02-01 (Microeconomics)
- NEP-PBE-2004-02-01 (Public Economics)
- NEP-PUB-2004-02-01 (Public Finance)
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- Wolfram F. Richter, 2007. "Geplante Steuerhinterziehung und ihre effiziente Bestrafung," RWI Materialien, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, pages 31, 08.
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