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Solving the Yitzhaki Paradox

  • Gwenola Trotin

    ()

    (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS)

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    This paper examines the determinants of tax evasion under prospect theory. For prospect theory, reference dependence is a fundamental element (the utility function depends on gains and losses relative to a reference point and not on final wealths as in expected utility theory). In order to identify the determinants of the income tax evasion decision, a general reference income is used. We show that results obtained under expected utility theory are not robust. In particular, tax evasion is increasing in the tax rate as soon as a suitable relative risk aversion measure is larger with auditing, than without. With this simple and testable condition, prospect theory provides a general framework consistent with empirical evidence for the tax evasion behaviour problem.

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    File URL: http://www.amse-aixmarseille.fr/sites/default/files/_dt/2012/wp_2012_-_nr_38.pdf
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    Paper provided by Aix-Marseille School of Economics, Marseille, France in its series AMSE Working Papers with number 1238.

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    Length: 21 pages
    Date of creation: 03 Sep 2012
    Date of revision:
    Handle: RePEc:aim:wpaimx:1238
    Contact details of provider: Web page: http://www.amse-aixmarseille.fr/en

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    1. Matthew Rabin & Richard H. Thaler, 2001. "Anomalies: Risk Aversion," Journal of Economic Perspectives, American Economic Association, vol. 15(1), pages 219-232, Winter.
    2. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
    3. Allingham, Michael G. & Sandmo, Agnar, 1972. "Income tax evasion: a theoretical analysis," Journal of Public Economics, Elsevier, vol. 1(3-4), pages 323-338, November.
    4. James Andreoni & Brian Erard & Jonathan Feinstein, 1998. "Tax Compliance," Journal of Economic Literature, American Economic Association, vol. 36(2), pages 818-860, June.
    5. Slemrod, Joel & Yitzhaki, Shlomo, 2002. "Tax avoidance, evasion, and administration," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 22, pages 1423-1470 Elsevier.
    6. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    7. Matthew Rabin, 2001. "Risk Aversion and Expected Utility Theory: A Calibration Theorem," Levine's Working Paper Archive 7667, David K. Levine.
    8. Alm, James & McClelland, Gary H. & Schulze, William D., 1992. "Why do people pay taxes?," Journal of Public Economics, Elsevier, vol. 48(1), pages 21-38, June.
    9. Friedland, Nehemiah & Maital, Shlomo & Rutenberg, Aryeh, 1978. "A simulation study of income tax evasion," Journal of Public Economics, Elsevier, vol. 10(1), pages 107-116, August.
    10. Clotfelter, Charles T, 1983. "Tax Evasion and Tax Rates: An Analysis of Individual Returns," The Review of Economics and Statistics, MIT Press, vol. 65(3), pages 363-73, August.
    11. Chris Starmer, 2000. "Developments in Non-expected Utility Theory: The Hunt for a Descriptive Theory of Choice under Risk," Journal of Economic Literature, American Economic Association, vol. 38(2), pages 332-382, June.
    12. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
    13. Michele Bernasconi & Alberto Zanardi, 2004. "Tax Evasion, Tax Rates, and Reference Dependence," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 60(3), pages 422-, September.
    14. Sanjit Dhami & Ali al-Nowaihi, 2005. "Why Do People Pay Taxes? Prospect Theory Versus Expected Utility Theory," Discussion Papers in Economics 05/23, Department of Economics, University of Leicester, revised Aug 2006.
    15. Erling Eide, 2001. "Rank dependent expected utility models of tax evasion," ICER Working Papers 27-2001, ICER - International Centre for Economic Research.
    16. Yaniv, Gideon, 1999. "Tax Compliance and Advance Tax Payments: A Prospect Theory Analysis," National Tax Journal, National Tax Association, vol. 52(n. 4), pages 753-64, December.
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