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Revisiting the tax compliance problem using prospect theory

Author

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  • Rao, R. Kavita

    (National Institute of Public Finance and Policy)

  • Tandon, Suranjali

    (National Institute of Public Finance and Policy)

Abstract

The paper presents a model for tax compliance based on prospect theory wherein an individual makes the decision whether to file, and declare a certain amount of income, or to not file based on a set of policy parameters as well as his/her preferences. The paper poses the question- at what incomes would individuals choose to file a return and answers the same using a model based on prospect theory. Further, simulations are presented to illustrate the impact of changes in tax rates, penalty and audit probability on the individual's preference to file. The results from the simulation show that for different values of policy parameters there exists crossover income at which individuals would choose to file a return. Given all else, at the exemption threshold of 0.1 million, individuals would choose to file a return at incomes greater than or equal to 0.6 million.

Suggested Citation

  • Rao, R. Kavita & Tandon, Suranjali, 2016. "Revisiting the tax compliance problem using prospect theory," Working Papers 16/169, National Institute of Public Finance and Policy.
    • Handle: RePEc:npf:wpaper:16/169
    Note: Working Paper 169, 2016
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    References listed on IDEAS

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    Cited by:

    1. Tandon, Suranjali & Rao, R. Kavita, 2017. "Trade Misinvoicing: What can we Measure?," Working Papers 17/200, National Institute of Public Finance and Policy.
    2. Tandon, Suranjali & Rao, R. Kavita, 2017. "Tax Compliance in India: An Experimental Approach," Working Papers 17/207, National Institute of Public Finance and Policy.

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    More about this item

    Keywords

    prospect theory ; compliance ; tax ; exemption threshold ; crossover income;
    All these keywords.

    JEL classification:

    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law

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