Question

Indicate how each of the following could impact tax evasion and explain why the effect takes place: a. An increase in MTRs. b. A decrease in MTRs. c. An increase in the complexity of the tax code. d. An increase in the probability that a taxpayer’s return will be audited. e. An increase in the penalty for tax evasion.

Answer 1

1. An increase in MTRs

An increase in marginal tax rates increases the incentives for tax evasion and this effect take place due to increase in the marginal benefit of tax evasion and downward shifting of marginal benefit curve.

2. A decrease in MTRs

A decrease in marginal tax rates decreases the incentive for tax evasion and this effect take place due to decrease in the marginal benefit of tax evasion and upward shifting of marginal benefit curve.

3. An increase in the complexity of the tax code

If there is an increase in the complexity of the tax code then it becomes more difficult for the authorities to determine if the evasion is taking place. This results in decrease in the marginal cost of tax evasion by decreasing the probability that the evasion will be detected.

4. An increase in the probability that a taxpayer’s return will be audited.

An increase in the probability that a taxpayer’s return will be audited decreases the chances of tax evasion by increasing its marginal cost which results in increase in the probability of the audit of taxpayer’s return.

e. An increase in the penalty for tax evasion.

An increase in the penalty for tax evasion increases its marginal cost which in turn decreases the amount of evasion.