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Prospect theory and tax evasion: a reconsideration of the Yitzhaki puzzle

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  • Amedeo Piolatto

    () (Universitat de Barcelona & IEB)

  • Matthew D. Rablen

    () (Brunel University)

Abstract

The standard expected utility model of tax evasion predicts that evasion is decreasing in the marginal tax rate (the Yitzhaki puzzle). The existing literature disagrees on whether prospect theory overturns the puzzle. We disentangle four distinct elements of prospect theory and find loss aversion and probability weighting to be redundant in respect of the puzzle. Prospect theory fails to reverse the puzzle for various classes of endogenous specification of the reference level. These classes include, as special cases, the most common specifications in the literature. New specifications of the reference level are needed, we conclude.

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  • Amedeo Piolatto & Matthew D. Rablen, 2014. "Prospect theory and tax evasion: a reconsideration of the Yitzhaki puzzle," Working Papers 2014/3, Institut d'Economia de Barcelona (IEB).
  • Handle: RePEc:ieb:wpaper:2013/6/doc2014-3
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    Cited by:

    1. Nigar Hashimzade & Gareth Myles & Frank Page & Matthew Rablen, 2015. "The use of agent-based modelling to investigate tax compliance," Economics of Governance, Springer, vol. 16(2), pages 143-164, May.
    2. repec:eee:joepsy:v:61:y:2017:i:c:p:225-243 is not listed on IDEAS
    3. Rao, R. Kavita & Tandon, Suranjali, 2016. "Revisiting the tax compliance problem using prospect theory," Working Papers 16/169, National Institute of Public Finance and Policy.
    4. R.Kavita Rao & Suranjali Tandon, 2016. "Revisiting the Tax Compliance Problem using Prospect Theory," Working Papers id:11225, eSocialSciences.
    5. Luigi Mittone & Fabrizio Panebianco & Alessandro Santoro, 2016. "The Bomb-Crater Effect of Tax Audits: Beyond Misperception of Chance," Working Papers 583, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    6. Duccio Gamannossi degl’Innocenti & Matthew D. Rablen, 2017. "Tax avoidance and optimal income tax enforcement," IFS Working Papers W17/08, Institute for Fiscal Studies.

    More about this item

    Keywords

    Prospect theory; tax evasion; Yitzhaki puzzle; stigma; diminishing sensitivity; reference dependence; endogenous audit probability; endogenous reference level;

    JEL classification:

    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law

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