Modeling Intrinsic and Extrinsic Tax Compliance

Abstract

This paper attempts to fill the gap between economic and behavioral literature on tax evasion.

We propose a micro-founded model whose results are consistent with the ‘Slippery Slope’ Framework and with the Expected Utility Theory. Individual taxpayers face the problem of deciding the fraction of income they wish to disclose to the government, based on their trust and perceived power of authorities. Trust is modeled as the voluntary compliance originated by the umbrella-term tax morale and power is shaped by the perceived enforcement, mainly motivated by individual risk-aversion. Furthermore, we made use of Agent-Based simulations to replicate the ‘slippery slope’ conditions which allowed us to test the effects of different parameters on tax evasion. Compliance is primarily enhanced by tax morale and risk aversion, while it is secondarily motivated by higher audit probabilities and penalty fees. Tax rates, however, play a negative effect on tax compliance, as agents are less willing to pay taxes whenever facing larger obligations. Additionally, we study taxpayer behavior when the audit rate is zero and when agents are inclined to make charitable donations. Above all, we derive the conditions under which individuals would fully-evade, partially evade, fully-comply or even over-comply as charitable giving in the absence of audits.

Keywords: Tax Evasion, Power, Trust, Simulations

JEL Classification: H26, H31, C63, A12