TAX EVASION: A TWO-PERIOD MODEL

Tingting Xiao (), Ke Liu () and Kin Keung Lai ()
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Tingting Xiao: School of Business and Management, Hong Kong University of Science and Technology, Kowloon, Hong Kong
Ke Liu: MADIS and National Center for Mathematics and Interdisciplinary Sciences, Academy of Mathematics and Systems Science, CAS, Beijing, P. R. China
Kin Keung Lai: Department of Management Sciences, City University of Hong Kong, Kowloon, Hong Kong;

Asia-Pacific Journal of Operational Research (APJOR), 2014, vol. 31, issue 03, 1-21

Abstract: We mainly study a taxpayer's optimal strategies of tax evasion and its relevant properties, in order to deduce some effective suggestions and theoretical bases for the tax authority to restrain tax evasion. Based on the Christiansen static model of tax evasion, we formulate a two-period model where the discovery of tax evasion in the second period induces a tax audit in the first period if it has not been done before. The taxpayer has to choose the amount of tax evasion in each period to maximize the total expected utility of the two periods. We show that the threat of having the first-period evasion discovered in the second period diminishes attractiveness of tax evasion in both periods. We also discuss the policy of audit power enhancement, where the audit probability in the second period will be increased if tax evasion is discovered in the first period. We find that this policy may play two roles. First, it can reduce the incentive of tax evasion in the second period if tax evasion is discovered in the first period. Second, a high potential increase of the audit probability may contain tax evasion in the first period but may cause more evasion in the second period.

Keywords: Tax evasion; expected utility; two-period model; retrospective audit; audit power enhancement (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1142/S0217595914500171

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