Advanced Search
MyIDEAS: Login to save this paper or follow this series

Optimal income taxation in the presence of tax evasion: Expected utility versus prospect theory

Contents:

Author Info

  • Sanjit Dhami

    ()

  • Ali al-Nowaihi

    ()

Abstract

The predictions of expected utility theory (EUT) applied to tax evasion are flawed on two counts: (i) They are quantitatively in error by huge orders of magnitude. (ii) Higher taxation is predicted to lower evasion, which is at variance with the evidence. An emerging literature in behavioral economics, most notably based on prospect theory (PT), has shown that behavioral economics is much better at explaining tax evasion. We extend this literature to incorporate issues of optimal taxation. As a benchmark for a successful theory, we require that it should explain, jointly, the facts on the tax rate, tax gap and the level of government expenditure. We find that when taxpayers use EUT (respectively, PT) and the optimal tax is derived from a social welfare function that also uses EUT (respectively, PT), then, the calibration results are completely at odds with the facts. However, when taxpayers use PT but the social welfare function uses standard EUT, there is a very close match between the predictions and the facts. This has important implications for context dependent preferences but also for the newly emerging literature on liberalism versus paternalism in behavioral economics.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.le.ac.uk/economics/research/RePEc/lec/leecon/dp07-10.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 07/10.

as in new window
Length:
Date of creation: Sep 2007
Date of revision:
Handle: RePEc:lec:leecon:07/10

Contact details of provider:
Postal: Department of Economics University of Leicester, University Road. Leicester. LE1 7RH. UK
Phone: +44 (0)116 252 2887
Fax: +44 (0)116 252 2908
Email:
Web page: http://www2.le.ac.uk/departments/economics
More information through EDIRC

Order Information:
Email:
Web: http://www2.le.ac.uk/departments/economics/research/discussion-papers

Related research

Keywords: Prospect theory; Expected utility theory; Tax evasion; Optimal taxation; Normative versus positive economics; Context dependent preferences; Liberalism; Paternalism;

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. d'ASPREMONT, Claude & GEVERS, Louis, . "Equity and the informational basis of collective choice," CORE Discussion Papers RP -350, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  2. Ali al-Nowaihi & Sanjit Dhami, 2010. "Probability Weighting Functions," Discussion Papers in Economics 10/10, Department of Economics, University of Leicester.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Sanjit Dhami & Ali al-Nowaihi, 2011. "An extension of the Becker proposition to non-expected utility theory," Discussion Papers in Economics 11/41, Department of Economics, University of Leicester.
  2. Giuseppe Ciccarone & Enrico Marchetti, 2011. "Macroeconomic effects of loss aversion in a signal extraction model," Working Papers 148, University of Rome La Sapienza, Department of Public Economics.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:lec:leecon:07/10. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mrs. Alexandra Mazzuoccolo).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.