Collaborative tax evasion and social norms: why deterrence does not work

This paper makes a preliminary attempt to model a phenomenon of collaborative tax evasion between a seller and his customer and incorporates the social norm into such collusive tax-evading activities. It is found that, due to the existence of the social norm, more prevalent collaborative tax evasion at the status quo tends to intensify the extent of the tax evasion itself; this thus furnishes a self-fulfilling equilibrium and it may also give rise to multiple equilibria. More importantly, we find that the snowballing effect stemming from social norm has a decisive influence not only in determining the conformity of consumers to the tax code, but also the deterrent effect of the authority's tax enforcement. If collaborative tax evasion is initially rampant, raising fines for tax evasion will give rise to a strong venal effect that will increase tax evasion. Once this perverse effect outweighs the usual deterrent effect associated with raising fines for tax evasion, a more severe fine may result in higher rather than lower tax evasion.