Cost Uncertainty and Taxpayer Compliance

The existence of a private cost borne by audited taxpayers affects the tax enforcement policy. This is so because tax auditors will face now two sources of uncertainty, namely, the typical one associated with taxpayers’ income and that associated with the taxpayers’ idiosyncratic attitude towards tax compliance. Moreover, the inspection policy can be exposed to some randomness from the taxpayers’ viewpoint due to the uncertainty about the audit cost borne by the tax authority. In this paper we provide an unified framework to analyze the effects of all these sources of uncertainty in a model of tax compliance with strategic interaction between auditors and taxpayers. We show that more variance in the distribution of the taxpayers’ private cost of evading raises both tax compliance and the ex-ante welfare of taxpayers. The effects of the uncertainty about the audit cost faced by the tax authority are generally ambiguous. We also discuss the implications of our model for the regressive (or progressive) bias of the effective tax system. ∗ This paper has benefited from comments made by participants in the Encuentro de Economia Pública (Santa Cruz de Tenerife) and by two anonymous referees of this Journal. Of course, they should not bear any responsibility for the remaining errors. Financial support from the Institute of Fiscal Studies (Spanish Ministry of Finance), Spanish Ministry of Science and Technology through grants SEC2003-306 and HI2001-0039, and from the Generalitat of Catalonia through the Barcelona Economics program of CREA and grant SGR2001-00162 is gratefully acknowledged. Correspondence address: Jordi Caballé. Universitat Autònoma de Barcelona. Departament d’Economia i d’Història Econòmica. Edifici B. 08193 Bellaterra (Barcelona). Spain. Phone: (34)-935.812.367. Fax: (34)-935.812.012. E-mail: [email protected] Barcelona Economics WP no 127