Salience of Tax Evasion Penalties Versus Detection Risk.

Abstract The sanction structure of the income tax system of the United States involves two primary elements: risk of detection and magnitude of penalty. Either element may be varied to alter the expected cost of tax evasion. The government has changed both elements: with little explicit recognition of the behavioral implications of such changes. This paper develops a hypothesis based on Kahneman and Tversky's prospect theory with respect to the sensitivity of individuals toward risk of detection versus magnitude of penalty. The results of a laboratory experiment designed to test the hypothesis are reported. The experiment provides evidence that the magnigtude of a penalty should be more closely examined as a component in the tax evasion sanction structure. The implications of these findings on the structure of future research also are discussed.