Loss Aversion and Tax evasion: Theory and Evidence

We consider income-source-dependent tax evasion and show that this is a generalizationof the well-known endowment effect.  We show that loss aversion, moral costs, mental ac-counting, and risk preferences play a key role in explaining key features of source-dependenttax evasion.  We provide evidence of the first direct link between subject-specific loss aver-sion  and  tax  evasion,  which  is  central  to  most  successful  modern  theoretical  accounts  oftax evasion.  We provide some evidence that risk aversion strengthens the cautionary effectof loss aversion and risk loving behavior attenuates, or reverses, it.  However, the underly-ing effect is also influenced by the source of income.  Evasion is increasing in the tax rateand  decreasing  in  the  audit  penalty,  as  predicted.   Our  paper  provides  novel  theoreticalinsights; proposes new methods in the estimation of the underlying behavioral parameters;and confirms the central predictions of the theory, while pointing out challenges for furtherdevelopments that existing theory is unable to account for.