Dynamics of tax evasion with back auditing,social norm updating,and public goods provision – An agent-based simulation

Income tax evasion dynamics and social interactions are analyzed with an agent-based model in heterogeneous populations. One novelty is the combined analysis of back auditing and ageing, which allows for incorporating psychological findings with respect to social norm updating over a taxpayer’s life cycle. Another novelty concerns individual’s social behavior regarding a Pareto-optimal provision of public goods. Simulation results support the counterintuitive conclusion drawn elsewhere in the literature that income tax compliance may decrease with raising marginal per capita returns (MPCRs). Yet, back auditing seems to have by far the strongest impact on the dynamics of fiscal fraud and also can help to curb the extent of tax evasion (ETE).     

THE EFFECTS OF DIFFERENTIAL MORTALITY RATES ON THE PROGRESSIVITY OF SOCIAL SECURITY

Does the Old-Age and Survivors Insurance portion of Social Security become regressive once we allow for the shorter lifespan of poor people? This paper compares the net returns of poor households to the net returns of other households after taking into account differential longevity. Earnings and Social Security tax and benefit histories are simulated for families of various income levels in the 1925 birth cohort. These tax and benefit profiles are then weighted by the agents' probabilities of survival. For some plausible values of key mortality parameters, differences in mortality eliminate the progressive spread in returns across income categories.     

Correlates of tax evasion

Tax evasion has increased in the United States. Estimates of evasion indicate that the amount of federal income taxes evaded equals the federal deficit. Thus, controlling tax evasion should be a major concern of future tax policy decisions. This study analyzes the effects of 18 variables that might affect tax evasion. Specifically, the variables were used as independent variables in discriminant analyses to determine their relationship to tax evasion. The results indicated that the variables affect different types of tax evasion differently, and that all variables do not significantly influence tax evasion. Policy implications are presented based on these results.     

The effects of official and unofficial information on tax compliance

The administration of tax policy has shifted its focus from enforcement to complementary instruments aimed at creating a social norm of tax compliance. In this paper we provide an analysis of the effects of information regarding the past degree of tax evasion at the social level on the current individual tax compliance behavior. We build an experiment where subjects declare their income after receiving either a communication of the average tax evasion rate (“official information”) or a private message from a group of randomly matched peers about their tax behavior (“unofficial information”). We use the experimental data to estimate a dynamic econometric model of tax evasion and find three main results. First, tax compliance is very persistent, but less so in the presence of information. Second, the higher the officially communicated past tax evasion rate, the higher the degree of persistence: former evaders are more likely to evade again (and evade more), and former compliant individuals are more likely to comply again (and, when evading, evade less). Third, when an unofficial communication of past evasion (compliance) from all their peers is received, both former evaders and compliant individuals are more likely to evade (comply) again.     

Income tax evasion dynamics: Evidence from an agent-based econophysics model

We analyze income tax evasion dynamics in a standard model of statistical mechanics, the Ising model of ferromagnetism. However, in contrast to previous research, we use an inhomogeneous multi-dimensional Ising model where the local degrees of freedom (agents) are subject to a specific social temperature and coupled to external fields which govern their social behavior. This new modeling frame allows for analyzing large societies of four different and interacting agent types. As a second novelty, our model may reproduce results from agent-based models that incorporate standard Allingham and Sandmo tax evasion features as well as results from existing two-dimensional Ising based tax evasion models. In this way, such kind of models may become more relevant and useful in economics as well as social psychology. We finally use our model for analyzing income tax evasion dynamics under different enforcement scenarios and point to some policy implications that may also be of interest for psychological research on tax compliance.     

Behavioral dynamics of tax evasion – A survey

Since the 1950s (Schmölders, 1959) it is well known that behavioral aspects have an influence on tax evasion or tax compliance. In particular, interactions among the various entities involved in the taxation process (e.g. taxpayers, law makers, tax practitioners, tax authorities, etc.), and the dynamics that these interactions may generate, seem to play an important role for the actual level of tax compliance. However, the mainstream neoclassical approach to tax evasion (Allingham & Sandmo, 1972) cannot account for such interactions and dynamics. Therefore, during the last two decades new approaches (e.g. lab experiments, agent-based modeling, etc.) have been developed with a view to model how behavioral dynamics may foster or prevent tax evasion. In addition, empirical evidence has been generated that supports a role for such interaction dynamics. In this contribution we survey the main developments in this research area and provide some suggestions for further research.     

Social norms and tax compliance: Framing the decision to pay tax

Observed levels of tax compliance are higher than predicted levels (when predictions are based on Allingham and Sandmo's neoclassical model of tax evasion). They are higher if social norms recognise the importance of compliance. But how do social norms frame decisions to pay tax? Can prospect theory be applied to shed insight into the way that social norms exert their influence? An analysis of questionnaire responses (from Italy and from the UK) suggests that they exert their influence by changing the reference points that individuals use when they code changes as ‘gains’, or ‘losses’. The evidence suggests that social norms frame the decision to pay tax by changing individuals’ perceptions of their entitlement to income. This consideration is important when designing policy to deter evasion.     

The backfiring effect of auditing on tax compliance

Using country-level data from 2003–2014, we examine the association between auditing level (measured as number of verification actions taken by tax authorities per 100 taxpayers in each country) and tax compliance (measured as business executives’ perception of tax evasion). Our hypothesis is that compliance increases until a certain auditing level is reached, and decreases beyond that level (i.e., an elevated auditing level backfires). In line with our expectation, the results of a series of tests indicate that there is a U-shaped association between auditing and tax evasion. We discuss how a potential backfiring effect may depend on the extent to which compliance is voluntary.     

Tax morale and fairness in conflict an experiment

Most people pay their taxes most of the time, even if the expected disutility from enforcement is too low to deter tax evasion. One potential reason is tax morale and, more specifically, rule following. In a lab experiment, we show that the willingness to pay taxes just because participants are told they are supposed to pay is indeed pronounced. Yet compliance is reduced if participants learn that income is heterogeneous. The effect is driven by participants with the lowest income. The reduction obtains irrespective of the tax regime. If the tax is proportional to income, or progressive, participants become more skeptical about the willingness of participants with high income to comply.     

The slippery slope framework on tax compliance: An attempt to formalization

Kirchler, Hoelzl, and Wahl (2008) presented with the so-called ‘slippery slope’ framework a new approach to understand tax compliance. The slippery slope approach supposes two routes to tax compliance: deterrence of tax evasion by audits and fines on the one hand, and building a trusting relationship with taxpayers by services and support on the other hand. In this paper, the slippery slope framework is formalized by assuming two groups of taxpayers: compliance-minded and evasion-minded persons. Defining reaction functions for persons of both groups with respect to coercive and persuasive power instruments of tax authorities, the typical slippery slope picture emerges that characterises the authorities’ work. As a consequence, both groups of policy tools are considered necessary to generate tax compliance. In addition to that, it is shown that coercive and persuasive power may be substitutes or complements to each other, depending of the parameters of the taxpayers’ reaction functions. As a further crucial determinant of tax compliance, the behaviour of the fellow citizens with respect to taxpaying is identified.     

Tax evasion, tax morale and policy maker's effectiveness

This paper aims to show that aggregate tax evasion may be largely explained by tax morale and that tax morale is dependent on the taxpayers’ intrinsic attitudes to honesty and social stigma. The theoretical hypothesis is that these attitudes are influenced by the taxpayers’ perceptions of the size of tax evasion as well as by their perceptions of the policy maker's effectiveness in exercising control over the relevant macroeconomic variables and safeguarding the interests of citizens. Applying Gordon's [Gordon, J.P.F., 1989. Individual morality and reputation costs as deterrents to tax evasion. European Economic Review 33(4), 797–805] framework, a dynamic model of aggregate tax evasion is proposed whereby multiple equilibria may emerge. Econometric analysis on Latin American countries supports the assumptions made in the model.     

Can strategic uncertainty help deter tax evasion? An experiment on auditing rules

This paper adds to the economic-psychological research on tax compliance by experimentally testing a simple auditing rule that induces strategic uncertainty among taxpayers. Under this rule, termed the bounded rule, taxpayers are informed of the maximum number of audits by a tax authority, so that the audit probability depends on the joint decisions among the taxpayers. We compare the bounded rule to the widely studied flat-rate rule, where taxpayers are informed that they will be audited with a constant probability. The experimental evidence shows that, as theoretically predicted, the bounded rule induces the same level of compliance as the flat-rate rule when strategic uncertainty is low, and a higher level of compliance when strategic uncertainty is high. The bounded rule also induces distinctive tax evasion dynamics compared to the flat-rate rule. The results suggest that increasing the level of strategic uncertainty among taxpayers could be an effective device to deter tax evasion.     

Taxes and economic behavior: Some interview data on tax evasion in Sweden

The article describes a survey carried out with a sample of 426 Swedish male adults. In telephone interviews questions were asked on attitudes to taxation, attitudes to tax crimes, the respondent's economic situation, tax evasion in the sense of underreporting income and overstating deductions, black payments, and tax planning, i.e. attempts to reduce the tax burden by legal means. Multivariate analyses of the data indicated that younger age, more opportunity for tax evasion than people in general, more negative attitudes than the average, and lenient attitudes to tax crimes were significant factors for explaining tax evasion and black payments. Financial strain was not a significant factor, since those who admitted tax evasion judged their economic situation more favorably than the rest of the sample.     

Taxpayer attitudes toward tax audit risk

Theoretical analyses on tax evasion usually assume that the taxpayer's behavior conforms to the Von Neumann-Morgenstern axioms for behavior under uncertainty, namely that the taxpayer is generally risk averse. This study found that the taxpayers' attitudes toward risk could be affected by (1) whether taxpayers perceive a tax payment as reduced income or as a loss; and (2) the magnitude of the tax savings and penalty structure. The findings, in general, agree more with the prospect theory than with the classical expected utility theory.     

An application of attribution and equity theories to tax evasion behavior

Traditional economic theory often has been utilized in an attempt to explain tax evasion behavior. Although economic consequences are important factors in the understanding of tax evasion behavior, they alone do not appear adequate to describe and predict the phenomenon. The results of two experiments which apply two social psychological theories, attribution theory and equity theory, to tax evasion judgments are reported. In the first experiment, the effects of personal need and degree of societal consensus were investigated. Both variables significantly affected recommended penalty judgments. In the second experiment, the effects of societal need and distinctiveness were studied. Neither societal need nor distinctiveness affected recommended penalty judgments. However, a significant interaction effect was found concerning subjects' behavioral intentions to evade. The present research suggests that both attribution theory and equity theory may be helpful in formulating hypotheses and enhancing our understanding of tax evasion behavior.     

Voting on redistribution with tax evasion

This paper analyzes voting on a linear income tax whose proceeds are redistributed lump sum to the taxpayers. Individuals can evade taxes, which leads to penalties if evasion is detected. Since preferences satisfy neither single peakedness nor single crossing, a voting equilibrium may not exist. When an equilibrium does exist, there are several possible outcomes. There may be ‘conventional’ equilibria where the rich are expropriated by the poor and middle class. There may be equilibria without full expropriation where redistribution is limited by the threat of evasion. Finally, there may be equilibria where redistribution goes from the middle class to the rich and poor.     

Reference dependent preferences,hedonic adaptation and tax evasion: Does the tax burden matter?

We study the effects of the tax burden on tax evasion both theoretically and experimentally. We develop a theoretical framework of tax evasion decisions that is based on two behavioral assumptions: (1) taxpayers are endowed with reference dependent preferences that are subject to hedonic adaptation and (2) in making their choices, taxpayers are affected by ethical concerns. The model generates new predictions on how a change in the tax rate affects the decision to evade taxes. Contrary to the classical expected utility theory, but in line with previous applications of reference dependent preferences to taxpayers’ decisions, an increase in the tax rate increases tax evasion. Moreover, as taxpayers adapt to the new legal tax rate, the decision to evade taxes becomes independent of the tax rate. We present results from a laboratory experiment that support the main predictions of the model.     

Reactance to taxation: Employers’ attitudes towards taxes

Taxes limit an individual’s freedom to make autonomous decisions about his or her income. A person is likely to respond to restrictions on his or her own freedom or perceived restrictions by reactance if opposition is a promising means for reestablishing the initial situation. Reactance as a consequence of perceived limitation of freedom is likely to manifest itself through change of attitudes, tax morale, and tax behavior. It is hypothesized that employers who have been running their business only a short time perceive taxes as a drastic cut in their profit and possibilities for investments and tend to feel limited their freedom and consequently display reactance more than employers who have had more extensive experience with their firms and the tax system. A sample of 117 employers with one or more dependent workers completed a questionnaire on (a) perceived limitation of one’s freedom through tax obligations, (b) attitudes towards tax evasion, (c) moral standards with regard to paying taxes, (d) actions to reduce or avoid taxes, and (e) demographic characteristics. As predicted, perceived restriction of freedom was correlated with positive attitudes toward tax evasion, lower tax morale, and reported tendencies to act against paying taxes. Employers who had run their firm only a short time felt greater loss of freedom and displayed greater reactance than employers with more extensive experience.     

An agent-based model of network effects on tax compliance and evasion

Agent-based models are flexible analytical tools suitable for exploring and understanding complex systems such as tax compliance and evasion. The agent-based model created in this research builds upon two other agent-based models of tax evasion, the Korobow et al., 2007, Hokamp and Pickhardt, 2010 models. The model utilizes their rules for taxpayer behavior and apprehension of tax evaders in order to test the effects of network topologies in the propagation of evasive behavior. Findings include that network structures have a significant impact on the dynamics of tax compliance, demonstrating that taxpayers are more likely to declare all their income in networks with higher levels of centrality across the agents, especially when faced with large penalties proportional to their incomes. These results suggest that network structures should be chosen selectively when modeling tax compliance, as different topologies yield different results. Additionally, this research analyzed the special case of a power law distribution and found that targeting highly interconnected individuals resulted in a lower mean gross tax rate than targeting disconnected individuals, due to the penalties inflating the mean gross tax rate in the latter case.     

International Profit‐Shifting out of Developing Countries and the Role of Tax Havens

This article contributes to the debate on how tax avoidance and evasion can hamper development efforts by investigating the link between profit‐shifting out of developing countries and tax havens. Analysis of more than 1500 multinational corporations (MNCs) operating in India shows that in 2010 those MNCs with links to tax havens reported lower profits and paid less in taxes per unit of asset than MNCs with no such links. This confirms the notion that when corporations have links to tax havens they enjoy higher incentives, because of the low tax rates, and opportunities to shift income because of the secrecy provisions tax havens offer.