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The cutoff policy of taxation when CRRA taxpayers differ in risk aversion coefficients and income: a proof

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  • Privileggi, Fabio

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Abstract

Under a cutoff policy, taxpayers can either report income as usual and run the risk of being audited, or report a "cutoff" income and hence pay a threshold tax that guarantees not being audited. Whereas the mainstream literature in this field assumes risk neutrality of taxpayers - with some notable exceptions like Chu (1990) and Glen Ueng and Yang (2001) - this paper assumes risk aversion instead: taxpayers have a Constant Relative Risk Aversion (CRRA) utility function and differ in terms of their relative risk aversion coefficient and income. The novel contribution of this work is that, under certain conditions, the cutoff is accepted by taxpayers with intermediate characteristics in terms of income and relative risk aversion. Contrary to the standard result in the literature, a full separation of types (the rich who accept the cutoff versus the poor who refuse it) does not arise. However, our results confirm that the cutoff policy violates equity, as only some taxpayers directly benefit. Nonetheless, the perception of this drawback may in practice be obfuscated because that exclusion does not necessarily affect only the poor.

Suggested Citation

  • Privileggi, Fabio, 2007. "The cutoff policy of taxation when CRRA taxpayers differ in risk aversion coefficients and income: a proof," POLIS Working Papers 99, Institute of Public Policy and Public Choice - POLIS.
  • Handle: RePEc:uca:ucapdv:99
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    Cited by:

    1. Stefania Ottone & Ferruccio Ponzano, 2011. "How people perceive the Welfare State: a real-effort experiment," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 58(2), pages 165-183, June.
    2. Daron Acemoglu & Davide Ticchi & Andrea Vindigni, 2010. "A Theory of Military Dictatorships," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(1), pages 1-42, January.
    3. Marchese, Carla, 2008. "The limits to growth then and now," POLIS Working Papers 105, Institute of Public Policy and Public Choice - POLIS.
    4. Piero Cavaleri & Michael Keren & Giovanni B. Ramello & Vittorio Valli, 2009. "Publishing an E-Journal on a Shoe String: Is It a Sustainable Project?," Economic Analysis and Policy, Elsevier, vol. 39(1), pages 89-101, March.

    More about this item

    Keywords

    cutoff; tax evasion; relative risk aversion.;

    JEL classification:

    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • D89 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Other
    • K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law

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