Tax evasion and unaccounted incomes: A theoretical approach

This paper analyzes the problem of tax evasion by incorporating a simple game theoretic framework wherein an individual is confronted with the decision of declaring income for taxation. The model is a re-formulation of Allingham Sandmo (1972) and Srinivasan (1973) original single period decision making problem and extends it to to a repeated game involving a tax payer and a tax authority. The game theoretic results shows that probability of audit and penalty rate are inversely related and that beyond a threshold penalty rate, the tax payer has no incentive to evade. In an infinitely repeated game setting, first, the threat of audit in all future periods acts as a deterrent to evasion and second, the result provides some intuitive understanding of the role of patience and equilibrium strategies in a long repetitive engagement that supports cooperation and prevents deviations.