The Hindu Business Line : There are no honest tax payers

OUR Finance Minister must be busy campaigning for his party, but this may come as bad news for him: That there are no absolutely honest taxpayers. Jaswant's backroom boys would have alerted him that a good proportion of the population falls in the grey side, but a categorical statement that "all taxpayers may under certain conditions become evaders" should come as a rude shock. I can hear that odd chuckle of some unnamed reader who says, "Oh, I thought it was only me!"

Well, this dismal view of humanity is what you would find in a recent research paper from the Tinbergen Institute, Amsterdam. Titled "Honesty in a Signalling Model of Tax Evasion," and written by Vitaly Pruzhansky, the paper does something impossible: it defines honesty as the force that may keep taxpayers from misreporting their income in situations, when there are positive gains from evasion in expected utility terms.

Not only that, for the sake of `convenience', the author classifies honesty into two - unconditional and selective. The analysis "completely characterises all perfect Bayesian Nash equilibria of the game, assesses their stability and welfare properties" and has enough equations for the econometric-minded, but if you were to concern yourself with readable text, you would learn that there are two schools of thinking about tax evasion. "The classical literature of the first generation models studied a taxpayer who solved a gambler's problem on how much to evade, given an exogenous tax rate, penalty for tax evasion and detection rate."

In short, what they felt was that increasing penalty is costless, whereas increasing probability of detection involves additional resources. So, they came to a drastic conclusion: "To maximise tax revenues minus costs of audits one should set an infinite fine and zero detection rate." Thus, to boost collections, penalty must be the maximum but inspection cost nil.

Second generation models of tax evasion used game-theoretic tools and found that "probability of detection negatively depended on the amount of reported income and that tax evasion declined with the rise of the taxpayer's income." By such logic, when India shines and incomes soar, there should be less evasion, probably because honesty too shines.

Vitaly adopts a `simpler and more intuitive' approach to the problem, by associating tax morale with inner honesty. So, the author does not aggregate all taxpayers in one population, "some fraction of which is always assumed to report honestly, whereas the members of the other one are expected utility maximisers."

If receptionist can be called `Head of Verbal Telecommunications', window-washers labelled `Optical Illumination Enhancers' and newspaper delivery boys titled `Information Hard Copy Delivery Service Providers', why deny tax evaders a more decent appellation?

The `basic model' presented in the paper has two players in the game and they are the taxpayer and the tax agency, and as in any game, there is `cheating'. The tax return filed by the taxpayer becomes the signal, the reported income is either `under' or `over', both of which are called `cheating' for the sake of `consistency'. "Without loss of generality", the paper assumes that "the agency prefers to audit and the taxpayer, to cheat."

The paper ends with Vitaly stating points `worth mentioning'. Among these, what comes first is this one: "Importance of honesty per se is immediate." That could be wishful thinking, perhaps, because the cop-n-thief game has to be played out forever, with incentives for both sides. Also, a world where thieves grow tired and turn good would make cops redundant. But that could be a different tack of research.

SayCheek@thehindu.co.in

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There are no honest tax payers