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VAT Compliance Incentives

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Document pages: 26 pages

Abstract: In this work I clarify VAT evasion incentives through a game theoreticalapproach. Traditionally, evasion has been linked to the decreasing riskaversion in higher revenues (Allingham and Sandmo (1972), Cowell (1985)(1990)). I claim tax evasion to be a rational choice when compliance isstochastically more expensive than evading, even in absence of controls andsanctions. I create a framework able to measure the incentives for taxpayers tocomply. The incentives here are deductions of specific VAT documented expensesfrom the income tax. The issue is very well known and deduction policies atwork in many countries. The aim is to compute the right parameters for eachprecise class of taxpayers. VAT evasion is a collusive conduct between the twocounterparts of the transaction. I therefore first explore the convenience forthe two private counterparts to agree on the joint evasion and to form acoalition. Crucial is that compliance incentives break the agreement among thetransaction participants coalition about evading. The game solution leads toboundaries for marginal tax rates or deduction percentages, depending onparameters, able to create incentives to comply The stylized example presentedhere for VAT policies, already in use in many countries, is an attempt toestablish a more general method for tax design, able to make compliance the "dominant strategy ", satisfying the "outside option " constraint represented byevasion, even in absence of audit and sanctions. The theoretical resultsderived here can be easily applied to real data for precise tax designengineering.

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