Tax Compliance and Rank-Dependent Expected Utility
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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