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

This paper makes a preliminary attempt to model a phenomenonof collaborative tax evasion between a seller and his customerand incorporates the social norm into such collusive tax-evadingactivities. It is found that, due to the existence of the socialnorm, more prevalent collaborative tax evasion at the statusquo tends to intensify the extent of the tax evasion itself;this thus furnishes a self-fulfilling equilibrium and it mayalso give rise to multiple equilibria. More importantly, wefind that the snowballing effect stemming from social norm hasa decisive influence not only in determining the conformityof consumers to the tax code, but also the deterrent effectof the authority's tax enforcement. If collaborative tax evasionis initially rampant, raising fines for tax evasion will giverise to a strong venal effect that will increase tax evasion.Once this perverse effect outweighs the usual deterrent effectassociated with raising fines for tax evasion, a more severefine may result in higher rather than lower tax evasion.