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An Equilibrium Model of Tax Compliance with a Bayesian Auditor and some 'Honest' Taxpayers

Reinganum, Jennifer F. and Wilde, Louis L. (1984) An Equilibrium Model of Tax Compliance with a Bayesian Auditor and some 'Honest' Taxpayers. Social Science Working Paper, 506. California Institute of Technology , Pasadena, CA. (Unpublished)

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Empirical work on tax compliance has yielded conservative estimates of unreported taxable income in the U.S. that average 10 to 15 percent of total taxable income for recent years. Moreover, it is held by many that the rate of noncompliance has been growing dramatically. This problem is widely perceived as one of eroding ethics—more and more people are ceasing to comply voluntarily and are instead acting "strategically" in response to the structure of the U.S. income tax laws. We propose a simple model of tax compliance in which an exogenously given fraction of taxpayers comply voluntarily, while the remainder behave strategically. We distinguish between a general decision to act strategically and a specific decision not to report honestly. This is done in an equilibrium setting where the IRS is allowed to adjust its audit policy in response to taxpayer behavior. Because the audit policy of the IRS is endogenous and thus co-determined with the reporting behavior of potential noncompliers, several non-intuitive results emerge. In particular, we find that an increase in the fraction of strategic taxpayers decreases the likelihood that a given strategic taxpayer fails to comply. In fact, the decrease in the likelihood of underreporting exactly offsets the increase in the fraction of strategic taxpayers, so that aggregate compliance (and net tax revenues) are unaffected.

Item Type:Report or Paper (Working Paper)
Additional Information:Revised. Original dated to December 1983. We would like to thank Kim Border and members of the Caltech Theory Workshop for helpful comments. The financial support of National Science Foundation Grant No. SES-8315422 is gratefully acknowledged.
Group:Social Science Working Papers
Funding AgencyGrant Number
Series Name:Social Science Working Paper
Issue or Number:506
Record Number:CaltechAUTHORS:20170920-155049868
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Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:81651
Deposited By: Jacquelyn Bussone
Deposited On:20 Sep 2017 23:03
Last Modified:03 Oct 2019 18:45

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