A Theory of the Tax Avoidance (Tax Planning) Continuum

Abstract

I model tax planning subject to challenges from a tax authority given an uneven tax code. The model captures the amount of deliberation required of the authority to properly challenge gray areas and the probability that it will prevail. The authority weighs these items when deciding whether to initiate the challenge. The ensuing unofficial shadow standard is a credible commitment which encourages less aggressive tax planning while saving the authority its deliberation costs. The shadow standard creates two groups – unchallenged taxpayers who abide by the shadow standard, and taxpayers with significantly more aggressive (and risky) positions. This explains the undersheltering paradox, and helps to resolve the longstanding lack agreement on precise definitions for tax aggressiveness and tax risk. Unlike the well-studied tax evasion paradigm (where more scrutiny induces more compliance), less scrutiny afforded by an increasing shadow standard may increase net tax collections under a tax planning paradigm.

Keywords: Vague tax law; Tax planning; Shadow standard; S-curve

JEL Classification: H26