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).     

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.     

THE CULTURE OF CORRUPTION,TAX EVASION,AND ECONOMIC GROWTH

This study uses a dynamic general equilibrium model to quantify the effects of corruption and tax evasion on fiscal policy and economic growth. The model is calibrated to match estimates of tax evasion in developing countries. The calibrated model is able to generate reasonable predictions for net tax rates, the corruption associated with public investment projects, and the negative correlation between corruption and tax revenue. The presence of corruption and evasion is shown to have significant, but not large, negative effects on economic growth. The relatively moderate effects help explain the absence of a robust negative correlation between growth and corruption in cross‐country data. The model also implies that cracking down on tax evasion before addressing corruption can be a bad idea and that higher wages for public officials can improve welfare. (JEL H3, O4)     

TAX RATES AND LABOR SUPPLY IN FISCAL EQUILIBRIUM

A central tenet of supply-side economics is that a balanced-budget reduction in the marginal tax rate on wage income increases aggregate labor supply. In contrast, the orthodox Keynesian analysis concludes that the relationship between tax rates and the economy-wide supply of labor is theoretically ambiguous. Our analysis of a general model reveals that these two propositions are associated, respectively, with the special assumptions of "compensated independence" and "ordinary independence" between leisure and public spending.     

EMPLOYMENT AND DEADWEIGHT LOSS EFFECTS OF OBSERVED NONWAGE LABOR COSTS

To assess the employment effects of labor costs, it is crucial to have reliable estimates of the labor cost elasticity of labor demand. Using a matched firm‐worker data set, we estimate a long‐run unconditional labor demand function, exploiting information on workers to correct for endogeneity in the determination of wages. We evaluate the employment and deadweight loss effects of observed employers' contributions imposed by labor laws (health insurance, training, and taxes) as well as of observed workers' deductions (social security and income tax). We find that nonwage labor costs reduce employment by 17% for white collars and by 53% for blue collars, with associated deadweight losses of 10% and 35% of total contributions, respectively. Since most firms undercomply with mandated employers' and workers' contributions, we find that full compliance would imply employment losses of 4% for white collars and 12% for blue collars, with respective associated deadweight losses of 2% and 6%. (JEL J23, J32)     

THE CONTROL OF EXTERNALITIES IN A GROWING URBAN ECONOMY

The received theory of externality control, which implicitly assumes that both the social marginal damage and marginal treatment cost schedules will remain fixed during the time any policy is operative, concludes that an effluent tax and an auction of rights to emit pollutants in the amount of a given emissions standard will be equally efficient in meeting that standard. We show that urban growth causes shifts in both schedules. These shifts in turn substantially increase the welfare loss from a fixed effluent tax relative to that from an auction market with a fixed number of licenses.     

DEADWEIGHT LOSSES AND THE SAVING RESPONSE TO A DEFICIT

Several recent empirical studies have challenged the conventional wisdom that deficits cause a higher interest rate. Many economists are, however, critical of the seemingly implied theoretical justification—that every individual fully recognizes the size of the deficit and the extent to which it increases future tax liabilities. This paper demonstrates that far weaker information assumptions are needed to obtain an aggregate savings response equal to the deficit: a reallocation of deadweight losses causes Ricardians to save more than their share of the deficit to keep consumption unaffected, allowing for a substantial fraction of Keynesians who save less than their share.     

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.     

True positives and false alarms in the detection of tax evasion

The probability of errors in tax returns has not been modeled explicitly before. However, corrections on individual tax returns, made by the fiscal authorities, may be related both to tax evasion and to errors made by the taxpayers. The probabilities of detecting tax evasion (true positives) and errors in tax returns (partly interpreted as false alarms) are specified and parametrized by variables known from the literature. In an empirical survey, the response to a questionnaire has been combined with information from the tax administration regarding tax returns. Taxpayers' willingness and ability to conceal income from the tax authorities are key factors with respect to tax evasion. Furthermore, the model enables the estimation of tax evasion probability, given the level of education and the opportunity to conceal income. The probabilities of tax evasion and errors could be explained to some extent.     

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.     

The consequences of different strategies for measuring tax evasion behavior

A critical review of existing measures of tax evasion suggests the need for innovative measurement strategies. Toward this end, a new method for documenting cases of individual tax evasion without compromising confidentiality is described. Results of an investigation in The Netherlands indicated negligible correspondence between scores on this measure and self-reports of tax evasion behavior. This outcome is particularly disturbing since the self-reports were obtained under conditions that should have maximized their veridicality. Additional analyses indicated that different sets of attitudes, norms and personality variables are correlated with admitted tax evasion and with patterns of actual behavior. The implications for future research are discussed.     

Measuring and explaining tax evasion: Improving self-reports using the crosswise model

Due to its sensitive nature, tax compliance is difficult to study empirically, and valid information on tax evasion is rare. More specifically, when directly asked on surveys, respondents are likely to underreport their evasion behavior. Such invalid responses not only bias prevalence estimates but may also obscure associations with individual predictors. To generate more valid estimates of tax evasion, we used a new method of data collection for sensitive questions, the crosswise model (CM). The CM is conceptually based on the randomized response technique (RRT), but due to its advanced design, it is better suited for large surveys than classical RRTs. In an experimental online survey, we compared the CM (N = 862) to standard direct questioning (DQ; N = 305). First, our results showed that the CM was able to elicit a higher proportion of self-stigmatizing reports of tax evasion by increasing privacy in the data collection process. Second, on average, we found stronger effects of our predictor variables on tax evasion in the CM condition compared with the DQ condition such that an egoistic personality and the opportunity for tax evasion predicted actual tax evasion only in the CM condition.     

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.     

Marginal Welfare Costs of Taxation with Human and Physical Capital

We develop a perfect foresight, overlapping generations model with intragenerational inequality and endogenous human and physical capital investment, and we calculate welfare costs for marginal reforms of taxation and public spending. Welfare costs are uniformly lower than in the equivalent static model where human and physical capital are fixed. Most of the upward bias in static estimates arises from fixed human capital because welfare cost is predominantly tax leakage from lower effective labor supply, but reallocating time between education and labor can leave effective labor supply unchanged. Hence, adjustments in human capital have an important mitigating influence on marginal welfare costs. (JEL D91, H20, H31, H41, J22, J24 )     

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.     

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.     

Tax evasion research: A critical appraisal and theoretical model

If social science is to contribute to an understanding of tax evasion behavior, it must develop accurate measures of evasion at the individual level, identify the variables associated with evasion, and construct compelling explanatory models. Toward this end, past research on tax evasion and noncompliance is reviewed with an emphasis on distinguishing between those variables that instigate the behavior and those that act as constraints against its occurence. The conclusions of this review suggest the potential value of a social psychological model of tax evasion behavior that specifies a set of situationally defined instigations and constraints and their logically analogous counterpart within the individual.     

THE WELFARE EFFECTS OF TEMPORARY TAX CUTS AND SUBSIDIES: THEORY,ESTIMATION, AND APPLICATIONS

This article presents a tractable and intuitive theory on the welfare effects of temporary tax cuts and subsidies, fiscal policies that I generically term “holidays.” The Kaldor–Hicks efficiency effects are theoretically ambiguous, with competing pro‐ and anti‐efficiency effects on newly incentivized versus time‐shifted purchases. To rectify this ambiguity I derive expressions for the welfare effects that are consistent with constant elasticity assumptions and depend only upon readily and reliably observed information. To demonstrate the framework's broad applicability, I analyze two different policies: the 2009 Cash for Clunkers program and states' sales tax holidays. I estimate that both policies generated substantial deadweight loss. (JEL H21, H30, D91)     

Distortionary Taxation and Optimal Public Spending on Productive Activities

Using a general‐equilibrium model with endogenous factor supplies, this article investigates the provision of factor‐augmenting public inputs. Such inputs are intermediate goods that affect production functions in a collective manner and give rise to increasing returns. Unlike with collective consumption goods, deviation from the first‐best condition for a public input is inappropriate if taxes are set optimally. When taxes are not optimal, a second‐best rule must include a feedback effect on revenue as well as the deadweight cost of taxes. Implications for benefit‐cost analysis and for interpretation of estimates of the social returns to public capital are explored.     

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.