A behavioral model of evolutionary dynamics and optimal regulation of tax evasion

Abstract

The paper studies the dynamics of compliance in a population of agents that decide whether to engage in tax evasion depending on an evolutionary adaptation process, when payoffs are assumed to have the realistic features of Prospect Theory utilities. The paper also considers the optimal control problem of a tax authority that targets the maximization of the expected stream of tax revenues choosing auditing effort. The analysis produces novel and rich results, including conditions for the convergence to an asymptotically stable interior equilibrium, the existence of multiple equilibria and discontinuities in the optimal control.