Prospect Theory and Tax Compliance

This chapter discusses prospect theory as an alternative approach in explaining tax compliance behavior. (Non)Compliance is frequently modeled as the outcome of a decision under risk, that is, the choice between a safe option of being compliant and a risky option of not complying with the law. Noncompliance results in either a better or a worse outcome than compliance, depending on whether the behavior is audited and penalized. The most prominent descriptive model to explain risky decisions is prospect theory. Many of this theory’s core ideas have been applied in theoretical and empirical studies of compliance. After a brief overview of prospect theory, this chapter summarizes empirical studies as examples for prospect theory inspired compliance research. It closes with a summary and critique of this approach.