Tax Compliance With Two-Sided Uncertainty

Abstract

Does government concealment of its audit policies increase or decrease taxpayer compliance? This article analyzes the impact of uncertainty about government audit policies on compliance using a game-theoretic model. The taxpayer is assumed to possess private information about his or her income, but does not know the tax agency's true audit capabilities. Similarly, the tax agency is assumed to possess private information about its audit technology (e.g., the cost of an audit or the probability that an audit will discover unreported income), but does not know a taxpayer's true income. The equilibrium of this game with two-sided uncertainty is determined and analyzed. The equilibrium is also compared to that of a game in which the taxpayer knows the tax agency's audit parameters. The results show that uncertain audit policies may well lead to less compliance, so that a government policy of concealment may be counterproductive.