Cumulative Prospect Theory in Taxpayer Decision Making: A Theoretical Model for Withholding Phenomenon

Empirical and experimental study suggests that tax withholding may have an effect on the level of tax compliance, but the tax evasion models under expected utility theory can not explain this. Introducing of the main idea of cumulative prospect theory, the paper builds a model of tax evasion in order to inquire into the relationship between tax compliance and tax withholding position. The model takes the current asset position as the reference point and makes quantitative analysis by mathematical reasoning. The results suggest that withholding system is necessary to promoting tax compliance and slightly high withholding position may induce full compliance with high penalty level. However, high advance payment accompanying with low penalty level may have a negative effect to tax compliance. Combining the results of the model and the situation of our country, the paper gives some suggestion about how to enhance the level of tax compliance.