Tax evasion with a conscience

• Published date: 01 February 2022
• Author: Martin Dufwenberg,Katarina Nordblom
• Date: 01 February 2022
• DOI: http://doi.org/10.1111/jpet.12547

Received: 28 July 2021

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Revised: 20 September 2021

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Accepted: 20 September 2021

DOI: 10.1111/jpet.12547

ORIGINAL ARTICLE

Tax evasion with a conscience

Martin Dufwenberg

1,2,3

|Katarina Nordblom

4,5

1

Department of Economics, University of

Arizona, Tucson, USA

2

University of Gothenburg, Gothenburg,

Sweden

3

CESifo, Munich, Germany

4

Department of Economics and CeCAR,

University of Gothenburg, Gothenburg,

Sweden

5

UCFS, Uppsala University, Uppsala,

Sweden

Correspondence

Martin Dufwenberg, Department of

Economics, University of Arizona,

Tucson, USA.

Email: martind@eller.arizona.edu

Funding information

Swedish Research Council,

Grant/Award Numbers: 2016‐01485‐3,

348‐2014‐3770

Abstract

How do moral concerns affect fraud and detection, for

example, tax compliance and the need for audits?

We propose answers by exploring a psychological

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×1×2×

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inspection game which incorporates

belief‐dependent guilt, unawareness, and third‐party

audience effects. Novel conclusions are drawn regard-

ing whose behavior is affected by moral concerns (it's

the inspector's more than the inspectee's) as well as the

policy issue whether to allow the use of a principle of

public access whereby tax returns are made public

information.

1|INTRODUCTION

A clear conscience may be a good pillow (as the proverb goes). Yet, this may not be enough to

deter criminal behavior. Shoplifting, fare dodging, use of narcotics, reneged arms control

treaties, embezzlement, corruption, moral hazard in insurance, and tax evasion happens. Law

enforcement (or contracting partners) react by engaging in costly audits, inspections, raids, and

crackdowns. The interaction is studied in the literature on inspection games.

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Mostly, no notion

of integrity, virtue, or morale is invoked though. It is natural to wonder whether conclusions

J Public Econ Theory. 2022;24:5–29. wileyonlinelibrary.com/journal/jpet

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This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which permits

use and distribution in any medium, provided the original work is properly cited, the use is non‐commercial and no modifications or

adaptations are made.

© 2021 The Authors. Journal of Public Economic Theory published by Wiley Periodicals LLC

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See, for example, Avenhaus et al. (2002) for an introduction and survey.

change if such matters are taken into account. We explore that issue, for a stylized and special

setting.

We focus on the impact of guilt. We assume that anticipated pangs of this emotion temper

individuals' inclinations to break the law, if they thereby hurt (or are perceived to hurt) others.

This is consistent with psychological evidence and experimental work by behavioral econo-

mists, which Battigalli and Dufwenberg (2007) (B&D) cite to motivate a formal approach to

how players' guilt shapes outcomes in games. They build on the framework of so‐called psy-

chological game theory (Battigalli & Dufwenberg, 2009,2021; Geanakoplos et al., 1989), in

which players' utilities depend on beliefs (about beliefs) about choices and not only on which

end node is reached (as in standard games). We apply B&D's theory to explore a 4‐player

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inspection game. There are two active players: an inspector and an inspectee, and

two passive players: the inspectee's alter ego, who is unaware of a legal rule, and an observer

who is hurt if the law is violated. While these additional players cannot actively choose, they

are crucial to the psychological analysis via their impact on beliefs.

From now on, we mainly frame our analysis in terms of tax evasion. Many scholars in the

extensive related literature (starting with Allingham & Sandmo, 1972) argued that "moral

sentiments”may be crucial for understanding compliance.

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Two caveats should be noted. First,

as a referee pointed out, the world of tax evasion is complex and we consider but a limited

special setting, involving a taxpayer's binary choice to report (or not) some extra income. We

disregard many additional realistic aspects (e.g., income heterogeneity, risk preferences, and

partial evasion) which the tax evasion literature often considered. Second, the insights we

derive may apply more broadly than to tax evasion. The readers should keep in mind the

examples we mentioned above (and perhaps in particular shoplifting and free‐riding on

a tram).

Following B&D, we explore two forms of moral anguish. Under “simple guilt”an evading

taxpayer cares about the extent to which he actually hurts fellow citizens relative to what they

expect. Under “guilt‐from‐blame”he rather worries about others' impressions regarding his

intentions to cause such harm. Each of these sentiments may make intuitive sense and it is not

clear whether one is more empirically relevant than the other. Our analysis contrasts these

forms of bad conscience with each other, and with a classical world with no remorse.

Whose behavior is most affected by the presence of taxpayer guilt? It may seem intuitive

that it would be the taxpayer, but in much of our analyses the amount of evasion does not

depend on the degree of guilt aversion. Instead, the inspection rate is affected. It would be a

mistake to portray this as a failure of guilt sentiments to reign in tax evasion. Less inspection is

needed when an equilibrium is played, and this may involve savings of public funds.

We also derive a novel conclusion regarding tax policy, namely whether to make tax returns

public information. The insight hinges crucially on an aspect that is idiosyncratic to psycho-

logical game theory. Namely, conclusions depend on the information structure across end

nodes. This could never happen in traditional games. When comparing private versus public tax

returns, these schemes provide different information to tax payers' neighbors. Neighbors make

no choices, yet, under guilt‐from‐blame, a taxpayer cares about the neighbor's inferences

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See, for example, Andreoni et al. (1998), Slemrod (2019), and Alm (2019) for excellent surveys of the tax evasion

literature. As regards tax morale, relevant work includes theory by Erard and Feinstein (1994), Bosco and Mittone

(1997), and Eisenhauer (2008) (unlike us, these authors do not use psychological game theory), experimental studies by

Coricelli et al. (2010), and Dulleck et al. (2016), and the broad discussion by Luttmer & Singhal (2014) and Alm (2019).

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DUFWENBERG AND NORDBLOM