Please use this identifier to cite or link to this item: http://hdl.handle.net/2381/4427
Title: Why Do People Pay Taxes? An Explanation Based On Loss Aversion And Overweighting of Low Probabilities
Authors: Dhami, Sanjit
al-Nowaihi, Ali
First Published: Dec-2003
Publisher: Dept. of Economics, University of Leicester.
Abstract: Given actual probabilities of audit and penalty rates observed in the real world, tax evasion should be an extremely attractive gamble to an expected utility maximizer. However, in practice, one observes too much compliance relative to the predictions of expected utility. This paper considers an alternative theoretical model that is based on Kahneman and Tversky's cumulative prospect theory. The model predicts empirically plausible magnitudes of tax evasion despite low audit probabilities and penalty rates. An increase in the tax rate leads to an increase in the amount evaded- a result, which is both, intuitive, and factual, but is contrary to the prediction made by expected utility theory. Furthermore, the optimal tax rates predicted by prospect theory, in the presence of tax evasion behaviour, are consistent with actual tax rates.
Series/Report no.: Discussion Papers in Economics
03/18
Links: http://www.le.ac.uk/economics/research/discussion/papers2003.html
http://hdl.handle.net/2381/4427
Type: Report
Appears in Collections:Reports, Dept. of Economics

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