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Abstract - While obligatory advance tax payments do not interfere with the taxpayer's evasion decision under expected utility theory, they do affect the decision to evade under prospect theory. The present paper applies prospect theory to a simple model of tax evasion, exploring the role that advance tax payments may play in enforcing tax laws. The paper demonstrates, as empirically found in the United States, that advance tax payments may substitute for costly detection efforts in enhancing compliance. However, contrary to a recent claim in the tax evasion literature, deliberate high advance tax payments are unlikely to eliminate the incentives for noncompliance.
INTRODUCTION
Empirical and experimental evidence suggests that advance tax payments may play an effective role in tax authorities' enforcement strategy. Cox and Plumley (CP, 1988) found that voluntary compliance rates in the United States increased consistently with the amount of refund that taxpayers expected to receive upon the filing of a tax return and decreased consistently with the amount of taxes that they still had to pay.' Chang et al. (1987) and Robben et al. (1990) confirmed experimentally the empirical findings for the United States and several European countries, whereas Carroll (1992), documenting diaries of taxpayers' tax-related thoughts and behaviors, found that taxpayers thought primarily in terms of the out-of-pocket gains and losses at the tine of filing, concluding that whether taxpayers expect to receive a refund or have to supplement their prepaid taxes is important for the understanding and control of taxpaying behavior.
In a recent contribution, Elffers and Hessing (EH, 1997) suggest, following Robben (1991) and Webley et al. (1991), that prospect theory, developed by Kahneman and Tversky (1979), may help explain taxpayers' observed behavior under obligatory advance tax payments, Offers and Hessing argue that when prepaid taxes are greater than the true tax liability, the taxpayer expects a gain from filing a return, whereas if prepaid taxes are less than the true tax liability@ they expect a loss. Hence, in the spirit of prospect theory, the taxpayer is risk averse with respect to the former case and risk seeking with respect to the latter. Consequently, he will opt to avoid risk in the former case and to take his chances in the latter. Offers and Hessing conclude that the...