JATA - Spring 1995

Volume 17, No. 1

Experimental Evidence of the Effect of Tax
Rate Uncertainty on Security Prices,
Investor Clienteles, and Tax Payments

Julie H. Collins and Daniel P. Murphy


This paper examines the effect of tax rate uncertainty on security prices, investor clienteles, and tax revenue. A laboratory market setting is employed where differentially taxed investors invest in three differentially taxed riskless securities (fully taxable, partially taxable, and non-taxable). The setting is replicated under conditions of investor tax rate certainty and uncertainty.

When tax rates are certain, prices reflect security tax differences and clienteles develop such that investors minimize their total (explicit plus implicit) tax burden. Tax rate uncertainty leads to decreased prices, hence increased returns, for the fully and partially taxable securities as investors demand a premium to hold these "risky" taxable securities. Tax uncertainty also impedes investor clientele formation and results in increased tax payments by investors.

An Investigation of the Effect of Detection
Risk Perceptions, Penalty Sanctions, and
Income Visibility on Tax Compliance

Gregory A. Carnes and Ted D. Englebrecht


It may be advantageous for those who are investigating tax compliance to set parameters such as detection rate and penalty levels at values similar to those that individuals actually face. We use penalty levels proxied at the sanction levels stipulated in the Internal Revenue Code (IRC) for omission of income to determine if penalties are an effective deterrent and to see if changes in magnitudes are salient. We measure detection risk as perceived detection risk. Additionally, we investigate the influence of income visibility on compliance and explore the relation between income visibility and detection risk.

The results indicate that low levels of penalty sanctions influence compliance behavior. Increases in sanction levels appear to be salient even when those increases are relatively small. Perceptions of detection risk and income visibility were also significantly related to compliance. After controlling for income visibility, taxpayers' compliance behavior was very strongly influenced by their detection risk perceptions.

A Comparison of Alternative Measures of
Tax Progressivity: The Case of the Child
and Dependent Care Credit

Ananth Seetharaman and Govind S. Iyer


Current tax progressivity studies reflect a significant bias in favor of the Suits index of tax progressivity over other tax progressivity indexes. Although the Suits index is not without merit, it fails to assess the impact of tax progressivity on income inequality. This limitation is significant when judged from the standpoint that a principal justification for tax progressivity is the expectation that it will reduce income inequality. In this study, a detailed analysis of the features, the nature, and the sources of the limitations of seven alternative tax progressivity indexes is presented. The indexes are then applied to examine whether or not the child and dependent care credit was progressive during the 1979-86 period. The empirical results, which are sensitive to the choice of the index, suggest that the practice of arbitrarily selecting and applying the Suits index will lead to incomplete inferences about the progressivity effects of tax systems.

The Economics of Taxpayer Venue Choice:
Effects of Informational Asymmetries

Gail Eynon and Kevin Stevens


Taxpayers unwilling to settle disputes with the IRS administratively must choose among several venues in order to defend their interests. This study examines the taxpayer's choice of venue from a game theory perspective. We describe the litigation process as a two-player game with asymmetric information, where taxpayers have private information as to their guilt or innocence. The IRS offers to settle out of court and taxpayers can either accept or reject this settlement demand. We find that the optimal IRS settlement demand depends upon the ability of the courts to discriminate between the guilty and the innocent, as well as upon the out-of-pocket legal costs of the players. Further, venue choice is never an informative signal when the IRS' goal is to maximize expected revenue. When minimization of expected incremental social costs is the IRS' objective function, the taxpayer's venue choice may in some cases transfer information to the IRS.