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Tax progressivity, income distribution and tax non-compliance

  • Damjanovic, Tatiana
  • Ulph, David

This article examines the determinants of tax non-compliance when we recognise the existence of an imperfectly competitive "tax advice" industry supplying schemes which help taxpayers reduce their tax liability. We apply a traditional industrial organisation framework to model the behaviour of this industry. This tells us that an important factor determining the equilibrium price and hence, the level of non-compliance, is the convexity of the demand schedule. We show that in this context, this convexity is affected by the distribution of pre-tax income, the progressivity of the tax-schedule and the way in which monitoring and penalties vary with income. It is shown that lower pre-tax income inequality as well as a less progressive tax code may cause more tax minimisation activities. Therefore, the frequently advocated policy of reducing the highest tax rate may fail as a policy directed at improving tax discipline. One way of offsetting the possible harm to tax compliance from a less progressive tax could be an adjustment of the penalty and monitoring functions.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 54 (2010)
Issue (Month): 4 (May)
Pages: 594-607

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Handle: RePEc:eee:eecrev:v:54:y:2010:i:4:p:594-607
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