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Tax Compliance and Rank-Dependent Expected Utility

  • Jean-Louis ARCAND

    ()

    (Institut des Hautes Etudes Internationales et du Développement)

  • Grégoire ROTA-GRAZIOSI

    ()

    (Centre d'Etudes et de Recherches sur le Développement International)

In this paper, we show that considering the classic Allingham and Sandmo (1972) tax compliance problem under Rank-Dependent Expected Utility (RDEU) axiomatics provides a simple explanation for the "excess" level of full compliance observed in empirical studies, and which standard Expected Utility (EU) axiomatics are unable to explain. RDEU axiomatics provide 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 at which full compliance becomes optimal for the consumer is significantly lower under RDEU axiomatics than in the EU case. We also show that the comparative statics of tax-evasion with respect to changes in the tax rate or in income are "weaker" than under EU axiomatics. We conclude by presenting numerical simulations using several different parameterizations of the probability weighting function that have been proposed in the literature.

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Paper provided by CERDI in its series Working Papers with number 200403.

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Length: 22
Date of creation: 2004
Date of revision:
Handle: RePEc:cdi:wpaper:460
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  1. Koskela, Erkki, 1983. "A note on progression, penalty schemes and tax evasion," Journal of Public Economics, Elsevier, vol. 22(1), pages 127-133, October.
  2. Bernasconi, Michele, 1998. "Tax evasion and orders of risk aversion," Journal of Public Economics, Elsevier, vol. 67(1), pages 123-134, January.
  3. Eduardo Engel & James Hines, 2000. "Understanding Tax Evasion Dynamics," Econometric Society World Congress 2000 Contributed Papers 1117, Econometric Society.
  4. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  5. 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.
  6. Segal, Uzi & Spivak, Avia, 1990. "First order versus second order risk aversion," Journal of Economic Theory, Elsevier, vol. 51(1), pages 111-125, June.
  7. Diecidue, Enrico & Wakker, Peter P, 2001. " On the Intuition of Rank-Dependent Utility," Journal of Risk and Uncertainty, Springer, vol. 23(3), pages 281-98, November.
  8. 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.
  9. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
  10. Ronald G. Cummings & Jorge Martinez-Vazquez & Michael McKee, 2001. "Cross Cultural Comparisions of Tax Compliance Behavior," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper0103, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
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