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Tax Compliance and Rank Dependent Expected Utility

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  • Jean-Louis Arcand

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

  • Grégoire Rota Graziosi

    (CERDI-CNRS, Université d'Auvergne, 65 bd François 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

Suggested Citation

  • Jean-Louis Arcand & Grégoire Rota Graziosi, 2005. "Tax Compliance and Rank Dependent Expected Utility," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 30(1), pages 57-69, June.
  • Handle: RePEc:pal:genrir:v:30:y:2005:i:1:p:57-69
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    Cited by:

    1. Hashimzade, Nigar & Myles, Gareth D. & Rablen, Matthew D., 2016. "Predictive analytics and the targeting of audits," Journal of Economic Behavior & Organization, Elsevier, vol. 124(C), pages 130-145.
    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, vol. 40(C), pages 134-146.
    3. Philipp Meyer-Brauns, 2014. "Optimal Auditing with Heterogeneous Audit Perceptions," Working Papers tax-mpg-rps-2014-06, Max Planck Institute for Tax Law and Public Finance.
    4. Francesco Busato & Francesco Giuli, 2014. "Tax evasion and Prospect Theory in a OLG economy," Departmental Working Papers of Economics - University 'Roma Tre' 0196, Department of Economics - University Roma Tre.

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