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Prospect theory and tax evasion: a reconsideration of the Yitzhaki puzzle

Amedeo Piolatto () and Matthew Rablen ()

Theory and Decision, 2017, vol. 82, issue 4, 543-565

Abstract: Abstract The standard expected utility (EUT) model of tax evasion predicts that evasion is decreasing in the marginal tax rate (the Yitzhaki puzzle). Recent literature shows cases in which incorporating prospect theory (PT) does and does not overturn the Puzzle. In a general environment that nests both PT and EUT preferences, we provide a detailed study of how the elements of PT affect the Puzzle. PT does not always reverse the Puzzle, hence we give and interpret conditions for when it does and does not. When allowing for stigma and/or variable audit probability, PT reverses the Puzzle in the same way and with the same limitations as does EUT, if equally augmented.

Keywords: Prospect theory; Tax evasion; Yitzhaki puzzle; Stigma; Diminishing sensitivity; Reference dependence; Variable audit probability; Endogenous reference level (search for similar items in EconPapers)
JEL-codes: H26 D81 K42 (search for similar items in EconPapers)
Date: 2017
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Related works:
Working Paper: Prospect theory and tax evasion: a reconsideration of the Yitzhaki puzzle (2014) Downloads
Working Paper: Prospect theory and tax evasion: a reconsideration of the Yitzhaki Puzzle (2013) Downloads
Working Paper: Prospect Theory and Tax Evasion: A Reconsideration of the Yitzhaki Puzzle (2013) Downloads
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