Prospect Theory and Tax Evasion: A Reconsideration of the Yitzhaki Puzzle

24 Pages Posted: 4 Dec 2013

See all articles by Amedeo Piolatto

Amedeo Piolatto

Autonomous University of Barcelona - Department of Economics and Economic History; Barcelona Economics Institute (IEB); Barcelona Graduate School of Economics (Barcelona GSE)

Matthew D. Rablen

University of Sheffield - Department of Economics

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Abstract

The standard expected utility model of tax evasion predicts that evasion is decreasing in the marginal tax rate (the Yitzhaki puzzle). The existing literature disagrees on whether prospect theory overturns the puzzle. We disentangle four distinct elements of prospect theory and find loss aversion and probability weighting to be redundant in respect of the puzzle. Prospect theory fails to reverse the puzzle for various classes of endogenous specification of the reference level. These classes include, as special cases, the most common specifications in the literature. New specifications of the reference level are needed, we conclude.

Keywords: prospect theory, tax evasion, Yitzhaki puzzle, stigma, diminishing sensitivity, reference dependence, endogenous audit probability, endogenous reference level

JEL Classification: H26, D81, K42

Suggested Citation

Piolatto, Amedeo and Rablen, Matthew D., Prospect Theory and Tax Evasion: A Reconsideration of the Yitzhaki Puzzle. IZA Discussion Paper No. 7760. Available at SSRN: https://ssrn.com/abstract=2363262

Amedeo Piolatto (Contact Author)

Autonomous University of Barcelona - Department of Economics and Economic History ( email )

Edifici B - Campus Bellaterra
Barcelona, 08193
Spain

HOME PAGE: http://https://sites.google.com/site/piolatto/

Barcelona Economics Institute (IEB) ( email )

c/ John M. Keynes, 1-11
Barcelona, 08034
Spain

HOME PAGE: http://https://sites.google.com/site/piolatto/

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Matthew D. Rablen

University of Sheffield - Department of Economics ( email )

9 Mappin Street
Sheffield, S1 4DT
United Kingdom

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