Tax Litigation, Tax Reporting Game, and Social Costs.

Abstract This study investigates the consequences of tax litigation on the equilibrium behaviors of taxpayers and a tax enforcement agency. Tax litigation is modeled for a situation in which tax laws are ambiguous and tax courts are used to resolve the disputes between taxpayers and the tax agency. This study examines the impact of both taxpayer uncertainty and economic factors such as litigation costs, tax rate, and audit costs upon the tax agency's revenue collections, the frequency of tax trials, and an aggregate level of audit and litigation costs. An increase in the taxpayers' litigation costs results in less aggressive reporting behavior, which increases the tax agency's revenue and reduces the aggregate level of audit and litigation costs. The effects of a rise in the tax agency's litigation costs are indeterminate. As the level of taxpayer uncertainty is elevated, the model indicates that there will be fewer tax trials and the aggregate audit and litigation costs will decline. However, an increase in tax rate does not necessarily decrease the aggregate audit and litigation costs nor increase the litigation frequency.