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Optimizing Tax Administration Policies with Machine Learning

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  • Pietro Battiston
  • Simona Gamba
  • Alessandro Santoro

Abstract

Tax authorities around the world are increasingly employing data mining and machine learning algorithms to predict individual behaviours. Although the traditional literature on optimal tax administration provides useful tools for ex-post evaluation of policies, it disregards the problem of which taxpayers to target. This study identifies and characterises a loss function that assigns a social cost to any prediction-based policy. We define such measure as the difference between the social welfare of a given policy and that of an ideal policy unaffected by prediction errors. We show how this loss function shares a relationship with the receiver operating characteristic curve, a standard statistical tool used to evaluate prediction performance. Subsequently, we apply our measure to predict inaccurate tax returns issued by self-employed and sole proprietorships in Italy. In our application, a random forest model provides the best prediction: we show how it can be interpreted using measures of variable importance developed in the machine learning literature.

Suggested Citation

  • Pietro Battiston & Simona Gamba & Alessandro Santoro, 2020. "Optimizing Tax Administration Policies with Machine Learning," Working Papers 436, University of Milano-Bicocca, Department of Economics, revised Mar 2020.
  • Handle: RePEc:mib:wpaper:436
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    References listed on IDEAS

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    More about this item

    Keywords

    policy prediction problems; tax behaviour; big data; machine learning;
    All these keywords.

    JEL classification:

    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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