Multiple Modes of Tax Evasion: Theory and Evidence from the TCMP

In general, theoretical and empirical studies of tax compliance conclude that increasing penalties and detection probabilities increase compliance. However, these conclusions are based on relatively simple models with a single mode of tax evasion. In this paper, we examine the theoretical and empirical implications of accounting for multiple modes of tax evasion. We find that an increase in enforcement effort in one mode has an ambiguous effect on compliance in the targeted mode as well as the other mode. In order to gain greater insight into taxpayer behavior, we use the 1985 TCMP to estimate an empirical model with two modes of evasion: income reporting and deductions reporting compliance. We find that taxpayers use alternative modes of evasion as substitutes. In other words, an increase in enforcement effort in a given mode leads to an increase in compliance in the targeted mode and a decrease in compliance in the other mode. We use our empirical estimates of the parameters in the model to conduct several simulations. We find that the net revenue effect of increased enforcement effort is positive.