ABSTRACT
This chapter presents a game theoretical model based on a peculiarity of the mixed-strategy Nash equilibrium in 2-by-2 games and demonstrates that, in the case of Nash equilibrium, a reduction of the payoffs to a taxpayer due to punishment has no effect on his or her choice if the Nash equilibrium is mixed. Taxpayers are assumed to maximize expected utility which depends on noncompliance detection probabilities, the magnitude of punishment and incomes and tax rates. The chapter proposes that more intensive monitoring and higher fines may crowd out tax morale so that an increase in deterrence may under some conditions have a perverse effect on compliance, i.e., tax evasion may increase and discusses alternative tax compliance policies. Bruno Frey argues that increased deterrence tends to undermine tax morale and thus countervails the deterrence effect which may result from an increase of the penalty if tax morale does not change.
