Crime and Punishment in Taxation: Deceit, Deterrence, and the Self-Adjusting Penalty

Avoidance and evasion continue to frustrate the government\u27s efforts to collect much-needed tax revenues. This Article articulates one of the reasons for this lack of success and proposes a new type of penalty that would strengthen tax enforcement while improving efficiency. Economic analysis of deterrence suggests that rational taxpayers choose avoidance and evasion strategies based on expected rather than nominal sanctions. I argue that many taxpayers do just that. Because the probability of detection varies dramatically among different items on a tax return while nominal penalties do not take the likelihood of detection into account, expected penalties for inconspicuous noncompliance are particularly low. Adjusting existing penalties will not solve the problem because what is (and is not) inconspicuous depends on a given return and, therefore, is not susceptible to the type of generalization on which the current penalties rely. This Article offers a novel solution. Because taxpayers often hide aggressive subtractions (such as deductions, credits, and losses) by mixing them with legitimate subtractions of the same type, I propose to set the new penalty to equal a fraction of the legitimate subtraction reported on the same line of a tax return that contains the illegitimate one. With this penalty in place, the harder it is for the government to find an aggressive transaction, the higher is the statutory sanction if the transaction is detected. The proposed penalty adjusts itself As a result, the inefficient incentives to hide noncompliance are diminished and deterrence is improved