Moral constraints and evasion of income tax

This article re-examines the decision of individual income tax evasion in the simple framework introduced by Allingham and Sandmo (1972), where the individual taxpayer decides how much of his income is invested in a safe asset (reported income) and in a risky asset (concealed income). These early models could not convincingly reproduce the empirically observed positive influence of higher tax rates and higher gross income on tax evasion simultaneously. This article replaces the standard assumption that risk aversion is the factor limiting the extent of evasion, by assuming risk-neutral taxpayers, and argues that this is a reasonable approximation. The observation that concealing income is costly leads to the conclusion that, instead of risk aversion, evasion costs such as concealment expenses and moral cost, could be the factors that limit tax evasion. The author attempts to produce the stylized facts—not explained by older models—for general tax and penalty schemes, including those where the standard model definitely fails to do so.http://ideas.repec.org/a/icf/icfjpf/v04y2006i1p7-31.htm