Journal of Public Economics 46 (1991) 29-49.

North-Holland

The economics of tax amnesties

Arun S. Malik
USDA, Washington, D.C. 2005, USA

Robert M. Schwab*
University of Maryland, College Park, MD 20742, USA

Received May 1989, revised version received January 1991

This paper examines some of the economic implications of tax amnesties. We present a model
where individuals are initially uncertain about the disutility from tax evasion when they lile their
tax returns. If they later learn that they would like to be more honest than they have been, an
amnesty gives them an opportunity to report additional income. We also show that as the
probability of an amnesty rises, people report less income. As a consequence, an optimal
collection policy requires the government to balance the cost of lost tax revenue against the
gains from an amnesty.

‘Do not be ashamed of mistakes - and so make them crimes.’

Confucius, c. 500 B.C.

1. Introduction

Tax amnesties have received a great deal of attention recently. As Joulfaian

(1989) notes, more than 25 states have conducted or authorized amnesties in
recent years. More than a dozen bills calling for a federal tax amnesty have
been introduced in Congress. The Democratic presidential candidate pro-
posed an amnesty as part of his plan to close the federal deficit.
The argument in favor of a tax amnesty is straightforward.’ Some tax

*We wish to thank Ronald Fisher, Anne Derbes, and participants of the Public Economics
workshop at the University of Maryland for their helpful comments and suggestions. We also
thank Thomas Atkinson and Robin Jenkins for their excellent work as our research assistants.
The paper was written while Malik was at the University of Maryland and Schwab was a
Gilbert White Fellow at Resources for the Future.
‘Leonard and Zeckhauser (1987) offer an excellent review of many of the arguments for and
against tax amnesties.

0047-2727/91/$03.50 0 1991-Elsevier Science Publishers B.V. All rights reserved

J.P.E.
30 AS. Malik and R.M. Schwab, Economics of tax amnesties

delinquents would now like to become honest taxpayers but are deterred
from doing so by the fines and embarrassment they face if they reveal their
past tax evasion. Thus, some people gain and no one loses if we offer an
amnesty; the government collects more tax revenue, but only from those
people who find that the benefit from complying with the tax law is greater
than the cost. And in some cases, amnesties have raised significant revenue:
$85 million in Massachusetts, $102 million in Michigan, $152 million in
Illinois, $147 million in California, and $401 million in New York.2
Amnesties also have vocal opponents, however, including the U.S. Trea-
sury. As Lerman (1986), Leonard and Zeckhauser (1987), and Alm and Beck
(1986) have argued, part of the opposition stems from the fear that an
amnesty now would encourage honest taxpayers to avoid paying taxes in the
future because they would anticipate further amnesties.3 Opponents have
also argued that it is incorrect to attribute the revenues collected during an
amnesty solely to the amnesty itself. Increased future compliance efforts are
typically announced in conjunction with an amnesty, and it is therefore
dificult to separate the effects of an increase in the probability of detection
from the effects of the amnesty.
Assessing these arguments is difficult since there exists little systematic
analysis of tax amnesties from which we can draw any firm conclusions.4
There is a substantial literature, beginning with Allingham and Sandmo
(1972), on the theory of income tax evasion, but it offers few insights on the
amnesty issue. In the standard tax evasion model, the taxpayer knows all of
the relevant enforcement parameters (such as the probability of detection) as
well as the disutility with the possibility that he will be audited. Given this
knowledge, he chooses the utility maximizing level of income to report.
Suppose we introduce an amnesty in the standard model. Under this
amnesty, the taxpayer would pay taxes but no penalties on any additional
income he chooses to report. But the taxpayer in the standard model would
never report any additional income. He has already chosen the optimal level
of evasion, and if he has not received any additional information, then this

‘These estimates are from the New York State Department of Taxation and Finance (1988).
For a review of state amnesties, also see Mikesell (1986). These estimates should be interpreted
cautiously inasmuch as they represent the gross, rather than net, revenue from a tax amnesty. As
we note below, it is necessary to subtract from gross revenue the expected value of the tines that
would have been collected on income reported during the amnesty, the foregone revenue if
people change their future behavior, and the cost of administering the amnesty program in order
to find net revenue. We thank the referee for raising the point.
3To minimize these effects, amnesties are typically offered on a ‘one-time’ only basis. Such
threats may not be creditable, however; if it made sense for the government to offer an amnesty
once, why would it not make sense again?
4Alm and Beck (1986) offer some theoretical and empirical results on the revenue effects on
amnesties. See Fisher, Goddeeris and Young (1989) for a very interesting analysis of the
Michigan amnesty.
 A.S. Malik and R.M. Schwab, Economics of tax amnesties 31

optimal level of evasion remains unchanged. Moreover, even if this amnesty

led the taxpayer to believe that amnesties might be offered in the future, his
future behavior would not change (as long as he believed that interest on
unpaid taxes would never be forgiven, as has been true under virtually all tax
amnesties). Thus, the standard tax-evasion model would predict that no one
would ever take advantage of an amnesty and the possibility of future
amnesties would never affect people’s future decisions.
How then can we explain why taxpayers take advantage of amnesties? We
argue that a simple and intuitively appealing explanation can be provided by
modeling the taxpayer’s behavior in an adaptive utility framework such as
that of Cyert and DeGroot (1987). In this framework, the individual does not
know his utility function with certainty but learns about it through
experience. The individual makes decisions by envisioning the consequences
of his actions and then choosing an action that maximizes his expected
utility. Upon actually experiencing the consequences of an action, the
individual may revise his beliefs about his utility function; this is especially
true if the action is one he has not taken before. As a result, under the same
set of circumstances, the individual may now choose an action that is quite
different from the one he chose previously. This notion of adaptive utility has
been employed by a number of authors, including Pollak (1978), Cohen and
Axelrod (1984), and Russell and Thaler (1985).
The adaptive utility framework suggests the following model of taxpayer
behavior in which amnesties are relevant. Initially, the taxpayer chooses the
amount of income to report that maximizes his expected utility, given
uncertainty about the disutility associated with the risk of being caught
evading taxes. Subsequently, the taxpayer may learn that the actual disutility
is high, e.g. he finds that the cost of lying awake at night worrying that his
hidden income will be discovered is larger than the benefit of lower taxes. If
an amnesty were offered, this taxpayer would report additional income even
if the probability of detection and tine remained unchanged.
The remainder of the paper is organized as follows. In section 2 we
consider a taxpayer whose utility function can take on one of two forms. In
one case he values honesty highly, and in the other he does not. The
taxpayer learns the form of his utility function after he reports his income.
We characterize this taxpayer’s tax-evasion decision given that he knows that
with some probability an amnesty will be offered after his preferences have
been revealed. In section 3 we examine the effects of changes in the
enforcement parameters on this taxpayer’s welfare and on his decision to
evade taxes. In section 4 we look at the implications of the adaptive utility
model for the design of an optimal tax-collection policy. In section 5 we
discuss variations of the adaptive utility model, and we examine the
relationship between our work and that of others. The final section offers a
brief summary and conclusions.
32 A.S. Malik and R.M. Schwab, Economics of tax amnesties

2. The taxpayer’s problem

Consider a taxpayer whose income, y, is given. Reported income is taxed

at the rate t. With probability p the taxpayer will be audited and assessed a
unit tine, f, on the income he failed to report, where f is greater than t.
In the spirit of the adaptive utility framework, the taxpayer does not know
his utility function with certainty. Specifically, with probability f3 his utility
will be some function u of after-tax income, and with probability (l-0) it
will be some function U. The taxpayer is risk averse and therefore u” and u”
are both negative. Let V(r) and U(r), respectively, be the expected utility
given that the taxpayer’s preferences are represented by II and u and that he
has chosen to report income of r. Thus,

W) = (1 - PNY - tr) + p4y - tr - f(y - r)),

U(r)=(l-p)u(y-tr)+pu(y-tr-f(y-r)). (2)

It is not difficult to see that V and U are strictly concave functions of r (so
V” and U” are negative) given that u and u are strictly concave functions of
income.
The utility functions u and u differ in that if the taxpayer knew with
certainty that his utility function were u, he would report more income to the
tax-collecting authority than he would if he knew his utility function were u.
Thus, the taxpayer is uncertain about the disutility associated with being
partially or completely dishonest. With probability f3 the disutility is high,
and the taxpayer would want to report most (perhaps all) of his income, and
with probability (1 - 0) the disutility is low, in which case he would want to
conceal a good portion of his income.’
One way to characterize the differences between the utility functions u and
u is that u exhibits greater absolute risk aversion than u. This would ensure
that more income is reported when preferences are given by u rather than u.~
Other interesting interpretations are possible. For example, suppose
people cannot be certain of the way family and friends will react when they
learn of a tax cheat’s behavior. The level of others’ disapproval is unknown

5There could be some set of policy parameter values for which the taxpayer would want to be
completely honest given either utility function. For these parameter values, we would need to
somehow define u and I: so that they were identical. We avoid this problem by restricting
attention to parameter values for which the taxpayer would not choose to report all of his
income initially. As a result, we also do not have to specify whether an honest filer has revealed
to him the amount of guilt that would have accompanied a dishonest return.
6Let a’=~-tr’-f(y-r’) and b=y-tr’, i=u, u. When the taxpayer’s utility function is u, the
level of income he reports, r”. is defined by the condition u’(a”)/u’(b”)=(l -p)(f-t)/pt, assuming
O<r”< y. Similarly, the level of income he reports when his utility function is v, r”, is defined by
u’(a”)/~‘(b”)=(l -p)(f-t)/pt. Let R’ denote the index of absolute risk aversion for utility function
i. R” > R” implies v’(cx)/u’(/f)> u’(cc)/u’(b) for x < /I [Pratt (1964, eq. (2O)J Since u” i b’ when r” < y,
we can therefore write o’(a”)/tl’(h”) > u’(a”)/u’(b”) =( I- p)(f - t)/pt. This implies r” must be greater
than r” since u’(a’)/u’(b’) is decreasing in ri given U”~0.
 A.S. Malik and R.M. Schwab, Economics of tax amnesties 33

until after the cheating is undertaken; upon learning the true level of
disapproval that accompanies tax cheating, the functional relationship
between utility and tax cheating is updated to reflect this information. Thus,
we could think of u as the taxpayer’s utility function if others judge cheats
harshly, and u as his utility function if others care little about tax avoidance.
In this case preferences are known, but one of the factors that determines the
optimal level of cheating given these stable preferences (others’ disapproval of
avoidance) is not.’
Let r” and r” represent the levels of reported income that maximize V and
U. Thus, (i) if r” and r” are both strictly positive, then v)(r”)= U’(F)=@ (ii)
by definition, r” is greater than r”; (iii) this inequality together with the strict
concavity of I/ and U implies that if for some r 2 0, V’(r) is less than or equal
to zero, then U’(r) must be negative, and similarly, (iv) if U’(r) is greater than
or equal to zero, then V’(r) must be positive. We will use these results below.
The taxpayer must choose an initial amount to report r* before he learns
which utility function he has (and before he learns whether or not he will be
audited). With probability c1the government will declare an amnesty after the
taxpayer’s utility function is revealed but before audits are conducted. If an
amnesty is declared, the taxpayer may report additional income. Let s” be the
amount of additional income the taxpayer will report if he learns that his
utility function is u and let s” be the additional amount he will report if his
utility function is a. Under the terms of the amnesty, s” and s” must be
non-negative.8 Then, the taxpayer’s problem is to choose r*, s”, and s” to
maximize

W=(l -a)[(1 -~)U(r*)+8V(r*)]+a[(l--8)U(r*+sU)+8V(r*+s”)], (3)

subject to the constraints that r*, s”, and s” must be greater than or equal to
zero.
The first-order conditions for the solution to this problem are:

dWpr*=(l -a)[(1 -tI)U’(r*)+dI/‘(r*)]

(44

r*( d W/i%*) = 0, (4b)

‘We thank an anonymous referee for raising this point.

‘This implies that the taxpayer cannot tile an amended return falsely declaring even less
income. Although, in principle, the taxpayer has this option, he is unlikely to pursue it because it
is likely to invite close scrutiny from the tax authority. If we did not include a constraint of this
form, the amnesty would not affect the taxpayer’s initial reporting decision. He would simply
report income equal to the optimal amount when there is no chance of an amnesty. If an
amnesty is offered, he would reduce the amount reported if he turns out to have utility function
u and would increase the amount if he has utility function v.
34 AS. Malik and R.M. Schwab, Economics of tax amnesties

aW/c%” = tx(1 - e) U’(r* + s”) _I 0, (5a)

dyaw/as”) =o, (5b)

(64

s”(aw/as”) =o. (6b)

The second-order conditions for the problem are satisfied since U and I/ are
concave.9

2.1. Non-filers

Consider the case of a taxpayer for whom (4a) holds when r* = 0 and who
therefore does not report any income initially. This so-called non-filer may or
may not choose to report income under an amnesty.” There are four
possibilities to consider, since (5a) and (6a) could hold as equalities or as
strict inequalities. First, suppose s” and s” were both positive. Then (5b) and
(6b) would require U’(Y’) = V’(s”) =O, implying that U’(O) and V’(0) were both
positive since V and V are strictly concave and s” and s” are positive. But
clearly (4a) could not hold in this case, and we can therefore rule out the
possibility that a non-filer would always report additional income if an
amnesty were offered.
Second, suppose s” were positive and s” were zero. Then (5a) would require
that U’(s”)=O, and (given the concavity of U) U’(O)>O, while (6a) would
require V’(0) = V’(s”) s 0. But we showed above that U’(r) > 0 implies b”(r) > 0,
and we can therefore rule out this possibility.
Third, suppose sU and s” were both zero. Then (5a) and (6a) would require
U’(0) = U’(s”) 50 and V’(0) = V’(s”) 50. These inequalities are consistent with
(4a). Therefore, it could be optimal for a non-tiler never to take advantage of
an amnesty.
Finally, suppose s” equals zero and s ” is greater than zero. This would
require: (i) V’(s”) =O, (ii) V’(0) > 0, and (iii) U’(0) = U’(s’) 50. These conditions
are internally consistent, so a non-tiler would report income under an
amnesty only if his utility function is revealed to be u.

2.2. Filers
In the more interesting case where the taxpayer reports some but not all of
his income initially (0 <r* < y), there are again four possibilities to consider.

9We assume throughout that the constraint that requires the taxpayer to report an amount
less than or equal to y is never binding.
“Empirical studies indicate that non-filers are among the most likely to take advantage of
amnesties. See Leonard and Zeckhauser (1987) and Fisher et al. (1989).
 AS. Malik and R.M. Schwab, Economics of tax amnesties 35

Two of these, s” > 0 with s” 20, can be ruled out using arguments similar to
those employed above. The combination s” = s’ = 0 can now also be ruled out
because (4a) cannot hold as an equality when V’(r)50 and U’(r) ~0.
Therefore, it cannot be optimal for a taxpayer never to take advantage of an
amnesty if he reports some income initially.
This leaves us with the solution s”=O, s”>O. As in the case of the non-filer,
the first-order conditions are internally consistent at this solution and we can
therefore characterize the taxpayer’s optimal compliance plan as follows.
Given V’(r* + s”) = 0, (4a) requires him to report initially an amount I* such
that

(1 -cc)eV(r*)= -(l -O)U’(r*). (7)

This condition can be interpreted as follows. With probability ~0, the

taxpayer will face an outcome where his utility function is revealed to be u
and an amnesty is declared. For this outcome, the level of income he reports
initially is unimportant since he will be able to adjust the total amount of
income he reports so that it is equal to the amount he would have reported
initially had he known his utility function with certainty (I* +s”= r”). This
outcome can therefore be ignored in determining the optimal value of r*.
With probability (1 -aO) the taxpayer will face one of the remaining two
outcomes, both of which are relevant to the choice of r*: (i) his utility
function is revealed to be v but an amnesty is not offered, or (ii) his utility
function is revealed to be u and an amnesty is or is not offered. With the first
outcome, the probability of which is (1 -u)O, the taxpayer would want to
report additional income but would be unable to do so. There would
therefore be gains from reporting more income initially. With the second
outcome, which has probability (1-O),the taxpayer would want to report
less income but, again, would be unable to do so. Here there would be losses
from reporting more income initially. At the optimum, the expected gains
from reporting more income initially [the LHS of (7)] just equal the expected
costs of doing so [the RHS of (7)].
We can also establish upper and lower bounds for r*. By definition,
V’(r”) =O. Therefore, V’(r* +s’) = 0 implies so =r”-r*; if an amnesty is
declared and the taxpayer’s utility function is v, he reports enough additional
income so that his total reported income is equal to the amount he would
have reported initially had he known with certainty he was an honest person
(i.e. that his utility function is u). Since sV is positive, r” must be greater than
r*. Again, by definition, U’(P) =0 and, as we showed, the optimal solution
requires U’(r*)<O. Since U is concave, it follows that r* must be greater than
r”. Thus, the taxpayer initially reports an amount that is less than the
amount he would report if he knew that he was honest but more than he
would report if he knew he was not, i.e. P>r* >I-“.
36 A.S. Malik and R.M. Schwab, Economics of tax amnesties

Finally, this analysis demonstrates that tax amnesties are irrelevant in the
standard tax-evasion model where people know the disutility from evasion
with certainty. Out model reduces to the Allingham and Sandmo (1972)
model if 8 = 0 or 0 = 1. If 0 = 0, the consumer never participates in an
amnesty because s’ always equals zero. If 8= 1, then (7) implies that the
consumer initially reports r” [because V’(r*) must equal zero in that case]; he
reports no additional income during an amnesty since s” always equals
r” - r*.

3. Comparative statics

In this section we summarize the effects of changes in the important

tax-enforcement parameters on the taxpayer’s welfare and his tax-evasion
decisions. We concentrate on the case of an individual who reports some of
his income initially, i.e. a filer. The results for a non-tiler are briefly discussed
at the end of the section. Some of the results presented are derived in the
appendix.

3.1. Welfare changes

Let W*(cc, p, t) be the maximized value of the objective function in (3)

given that the government will offer an amnesty with probability CI, the
probability of an audit is p, and the tax rate is t.” Then the envelope
theorem implies

Since the optimal value of s” is zero, the term inside the first set of brackets
on the right-hand side of (8) vanishes. Given that (r*+s”) equals r”, and r”
maximizes V, V(r* + s”) must be greater than V(r*). Thus, aW*/da must be
positive; increasing the probability of an amnesty increases the taxpayer’s
welfare.
We can offer the following interpretation of (8). The probability that an
amnesty will be offered and that the taxpayer will take advantage of that
offer is ~0. If he does take advantage of the amnesty, he has the opportunity
now to report the optimal level of income given that his preferences are
represented by u. Thus, the taxpayer gains [V(r* +s”)- V(r*)] =
[V(r”) - V(r*)] if he participates in an amnesty, and therefore the expected

“Although the fine rate, f, is also a policy variable, little is learned from the first-order
condition for this variable. However, the taxpayer’s risk aversion does imply that it is not
necessarily optimal to set f as high as possible.
 AS. Malik and R.M. Schwab, Economics of tax amnesties 37

value of an amnesty offered with probability a is &[V(r* -t-s”)- V(r*)]. Eq.

(8) follows directly.
In the appendix we show

aW*
-= -E(%), (9)
at

where x is the marginal utility of income, r”is total reported income, and the
expectation is taken over the eight possible outcomes (the taxpayer’s
preferences are u or u, an amnesty is or is not offered, and the taxpayer is or
is not audited). dW*/at is negative, and can be interpreted as follows.
Suppose the government were to increase the tax rate by dt. Then in a state
of the world where the taxpayer has reported income of r and his marginal
utility is 1, his income would fall by r dt and his utility would fall by Ar dt.
Then, the expectation of ilrdt across outcomes equals the impact of this
change in tax policy on ex ante expected utility, as shown in (9).
We also show in the appendix that aW*/ap is negative; it equals the
expected loss in utility from an audit, where the expectation is taken across
the amnesty and preferences.

3.2. Changes in evasion

Total differentiation of (7) reveals

ar* O[ V(r*) - V(r* + s”)]

acC=(l -QU”(r*)+(l -c#l/“(r*)
(10)

We showed that V’(r*) must be positive and that V’(r*+s”) must equal zero.
Therefore, since U and I/ are concave, &*/au must be negative. This result is
consistent with the fears voiced by critics of tax amnesties: as the probability
of amnesty rises, people report less of their income to the tax authorities.
Total differentiation of the optimality condition V(r* + s”) =0 reveals
&“/au= -&*/au, which must be positive. The interpretation of this result is
straightforward. As we argued above, if the taxpayer takes advantage of the
amnesty, he will declare enough additional income so that in total he has
declared the same amount he would have declared initially had he known
that his utility function were u, i.e. s” = r” - r*. Thus, if the amount he reports
initially falls by one dollar, then the amount he will report during an
amnesty must rise by one dollar.
Of perhaps greater interest is the impact of changes in a on the
government’s expected revenues, including the tax revenue collected during
38 AS. Malik and R.M. Schwab, Economics of tax amnesties

amnesties and the fines for evasion. We can characterize expected revenues as
follows. Consider a taxpayer who initially declares income of r*. The
government will collect tr* from this taxpayer with certainty. It will collect
an additional ts” in taxes if an amnesty is offered and the taxpayer has utility
function v, an event that occurs with probability ~0. As for line revenues, the
government will collect f(y-r* -s”) if the taxpayer is audited after taking
advantage of an amnesty, the probability of which is c&p. If an amnesty is
not offered or the taxpayer does not take advantage of one, an event with
probability (1 - ad)p, the government will collect lines of S(y- u*). Thus,
expected revenues T are given by

T= tr* + ad(ts”) + cdp[f(y-r* -s”)] +( I -crd)p[f(y-r*)]

=pfy+(t-pf)(r*+cds”). (11)

Therefore,

o’T/da = (t - pj’)[(&*/&) + ccQ(&“/&) + Ss’]

=(t-pf)[(l-m9)(dr*/i3x)+Os”], (12)

where the second line in (12) follows from our result as”/&= -&*/da. Eq.
(12) emphasizes the distinction between gross and net revenue from a tax
amnesty. Within the content of our model, the former equals t&s”; to find the
latter, we must recognize that in the absence of the amnesty, lines would
have been collected on part of the income reported during the amnesty
(pfds”) and that the amnesty will affect people’s future reporting decisions
(t -pf)[(l - aO)(dr*/da)].”
For a risk-averse taxpayer to conceal some income (which we assume he
does), the tax rate he pays on this income with certainty t must be greater
than the expected line he pays if he cheats, pf. Therefore, the expression in
the first set of parentheses in (12) is positive. However, the sign of the
expression in brackets is unclear since s” must be positive while dr*/& is
negative. Thus, in general, the impact of increasing the probability of an
amnesty on expected tax revenues is ambiguous; it will be negative if the tax
revenues lost as a result of lower compliance exceed the tax revenues gained
from more frequent amnesties.
If the utility function u exhibits risk-neutrality, it can be shown that dT/&
is always negative. With u” =O, U” = 0, and therefore &-*@a reduces to

“In a more complete model we would also need to deduct other costs, such as the cost of
administering the amnesty measured both in terms of explicit costs and foregone tax collections,
from gross revenue in order to derive net revenue.
 A.S. Malik and R.M. Schwab, Economics of tax amnesties 39

V’(r*)/(l - ~)l/“(r*).‘~ Using a linear approximation of C”(.) around I*, the

first-order condition for s” can be written as V’(r* + s”) = V’(r*) + V”(r*)s” = 0,
which implies s” = - V’(r*)/V”(r*). Substituting these expressions in (12) gives

which is unambiguously negative. l4

Turning to the effects of shifts in the other policy parameters, we show in
the appendix that raising p increases initial compliance (ar*/ap is positive),
but that, in general, the effect of raising t is unclear. If the taxpayer has
decreasing absolute risk aversion, h-*/at can be positive or negative; if the
taxpayer is risk-neutral or, less plausibly, has increasing absolute risk
aversion, &*/at is negative (the expected result). These results are consistent
with those from the Allingham and Sandmo (1972) model, where amnesties
are not present.
The impact of changes in p and t on expected revenues are given by

aT/ap=f(y-r* -&“) +(t-pf)[(l -c&) ar*/ap], (13)

aT/at=(r*+CleS”)+(t-ppf)[(i-ae)ar*/atl. (14)

aT/ap must be positive: if p rises, revenues rise as a result of the increase in

the expected tines [the first term on the RHS of (13)] and because of
decreased evasion. Assuming ar*j& is negative, the sign of dT/dt is unclear.
We will be on the positively sloped portion of the Laffer curve only if the
additional revenues from the existing tax base offset the effects of lower
compliance.
These results, which are for a tiler, change for a non-filer only to the extent
that the strict inequalities obtained must be weakened. For instance,
increasing the probability of an audit would induce the non-tiler to report
some income only if (4a) holds as an equality when r* =O. Similarly,
increasing the probability of an amnesty would improve the non-tiler’s
welfare only if he takes advantage of one, that is, only if s”>O. Otherwise, the
probability of an amnesty is irrelevant to the non-tiler.

13When u”=O the taxpayer will choose the corner solution, r”=O, given the constant marginal
expected fine, pf:
14More generally, substituting s”= - V’(r*)/V”(r*) in (12) yields aT/da= Q(l -tI)V’[V’- U”]/
V”[(l -e)U”+(l +a)BV”], with all functions evaluated at r*. The sign of this expression depends
on that of [V-U”], which in turn depends on the relative magnitude of u” and u”. If u” is
greater than U” in absolute value, aT/da is negative. Although -u”> -u” is not ensured by the
assumption that u exhibits greater absolute risk aversion than u, the inequality is likely to hold.
40 AS. Malik and R.M. Schwab, Economics of tax amnesties

4. Optimal tax-collection policy

We now turn to the role of a tax amnesty in an optimal collection policy.

Suppose the government plans to spend an exogenously determined amount
G, in addition to funding its tax-collection agency. The costs of this agency,
which we denote by c, is a function of the probability it will apprehend a tax
evader. Additional funds are required if the probability of detection is to rise.
Thus, c = c(p) and c’ > 0; in addition, we assume c” >O, i.e. the marginal cost
of detection is increasing.
The government’s objective is to choose an enforcement policy that
maximizes the welfare of its constituents, subject to a revenue constraint and
a constraint that the probability of an amnesty be less than or equal to one
(the definition of a probability).15 Thus, the government must choose IX, p,
and t to

max W*(cc, p, t) (15)

s.t. T(a, p, t) -c(p) - GZO,

1-azo.

The first-order conditions for this problem require, in part,

~3w*/da
+ S(aT/aa) - y = 0, (164

aw*/ap + s[(aT/ap)
- ~‘1 = 0,

a w*lat + iqaT/at) = 0, (164

where 6 and y are, respectively, the Lagrange multipliers associated with the
budget constraint and the constraint on or.
Suppose first that expected revenues rise when the probability of an
amnesty rises, i.e. the loss in revenues from lower compliance is offset by the
revenues collected during more frequent amnesties and therefore dT/da is
positive. We showed that dW*/& is positive. Since 6 cannot be negative, if
arpa is positive, then y must be positive and therefore CI must equal one.
This result should not be surprising. We know that amnesties increase the

‘51t has been argued in the literature on crime and punishment that the social welfare
function should not have among its arguments the utility levels of criminals. In the context of
this paper, such an argument would imply that the objective function should only capture the
welfare of relatively honest taxpayers. However, given the structure of the model, it is impossible
to tell ex ante whether an individual is relatively honest or dishonest, that is, whether the
taxpayer’s preferences are given by u or by II.
 A.S. Malik and R.M. Schwab, Economics of tax amnesties 41

taxpayer’s welfare; if amnesties also raise revenue, then we should declare one
every year.i6
A more interesting problem arises if an increase in the frequency of
amnesties lowers revenue. In order to examine this problem, we assume
throughout the rest of the paper that aT/au is negative and that the optimal
value of u is less than one. In this case, 6 must be positive and the revenue
constraint must hold as an equality. If 6 is positive, then (16b) and (16~)
imply that [(aT/ap)-c’] and aT/at must be positive since, as we showed
above, 8 W*/ap and 8 W*/& are both negative. Thus, in an optimal collection
policy, the cost of increasing the probability of detection will always be less
than the associated increase in tax revenues and the government will always
be located on the positively sloped portion of the Laffer curve. Slemrod and
Yitzhaki (1987) reach similar conclusions in a model without amnesties.
We can gain some further insights on the optimal probability of an
amnesty by recasting the problem slightly. The government budget constraint
implicitly defines the tax rate t as a function of the other two enforcement
parameters, cc and p. Total differentiation of that constraint implies
atlap = - [(aT/ap) - dy(aT/at) and at/au = - (aT/acq(aT/at). Under our
assumptions, it is clear that, in an optimal program, atlap will be negative
and at/& will be positive.
Given these results and our characterization of aW*/& in (9) we can re-
write the optimality conditions as

a w*/au = E(3j(at/acr). (174

a w*/ap = E@j(at/ap). (17’3

The first condition can be interpreted as follows. Suppose the government

were to increase the probability of an amnesty by da. As a consequence, it
would also have to raise the tax rate by (&/&)da. After-tax income would
fall in each state of the world by the product of the change in the tax rate
and the amount of reported income; in turn, utility in each state would fall
by the product of the marginal utility of income and the change in after-tax
income. Thus, the RHS of (17a) represents the loss of expected utility from
the increase in the tax rate that is required to offset the revenue loss from an

16The frequency with which amnesties are offered may influence the sign of 8T/&; this effect
is not captured in our essentially timeless model. For instance, if preferences are stable over time
and an amnesty has been offered, additional revenues would be generated by future amnesties
only from taxpayers who were not on the tax rolls during the previous amnesty. According to
our model, taxpayers who were on the rolls during that amnesty would know their utility
functions with certainty and would not have any reason to participate in subsequent amnesties.
42 AS. Malik and R.M. Schwab, Economics of tax amnesties

increase in the probability of an amnesty. The LHS, of course, is the increase

in expected utility from raising CI. Thus, (17a) states that an optimal
collection policy requires us to continue to increase the probability of an
amnesty up to the point that the marginal willingness to pay for an amnesty
equals its marginal cost. The second condition offers a similar characteriza-
tion of the optimal probability of an audit.

5. Alternative models

The adaptive utility model discussed above is not the only model that can
explain participation in amnesties. Participation can also be explained by
models in which the taxpayer is uncertain not about his utility function but
about the values of the parameters that enter his decision problem. As in the
adaptive utility model, the uncertainty about the parameter values is resolved
over time. Such parameter-uncertainty models can be patterned very closely
on the adaptive utility model, and will generate similar results.
Consider, for example, a model in which the taxpayer is uncertain about
the probability of being audited at the time he must file his original return.
He subsequently learns the value of the audit probability and, if an amnesty
is offered, can report more income.
Let 0 now denote the probability that the audit probability will be high
(p,,) and (l-0) the probability that it will be low (p,J. Accordingly, redefine
V(r) and U(r) to be the taxpayer’s expected utility when the audit probability
is high and low, respectively:

W-) = (1 -p&O - tr) + P&Y - tr - f(y - r)), (18)

U(r) = (1 - PMY - tr) + PAY - tr --f(y - r)), (19)

where u represents the taxpayer’s now certain preferences.

As before, let r’ and r” represent the levels of reported income that
maximize V and U, so V’(r”) = U’(F) = 0. l7 Since reported income is increas-
ing in the audit probability, r” is greater than r”; that is, the taxpayer would
report more income if he knew with certainty that the audit probability were
high rather than low. One can also verify that V’(r) is greater than U’(r) for
any given level of reported income. This implies that if for some r 20,
U’(r) 5 0, then V’(r) > 0, and if U’(r) >=0, then V’(r) > 0.
These properties of the expected utility functions U and I/ are the same as

“We assume here that both rV and r” are positive; it is straightforward to extend the analysis
to the case where r” or r” is zero.
 AS. Malik and R.M. Schwab, Economics of tax amnesties 43

those for the adaptive utility model. It should therefore not be surprising that
the taxpayer’s decision problem and the associated first-order conditions for
this parameter-uncertainty model are identical to those for the adaptive
utility model [eqs. (3)<7)]. Moreover, it is not difficult to verify that the
results generated by the two models are quite similar. They differ only in the
comparative static results for the audit probability, which change in a very
predictable manner.
Instead of uncertainty about the audit probability, variations of the above
model could allow for uncertainty about the penalty for tax evasion or about
income. Andreoni (1988), for example, presents a one-period model in which
the taxpayer is subject to a random (and untaxed) shock to consumption.
The shock occurs after the date returns are originally due but before any
amnesty is offered. l8 The taxpayer is aware of the possibility of such a shock
at the time he files his original return and chooses the level of income to
report accordingly. If an amnesty is offered, the taxpayer may find it optimal
to report more income if absolute risk aversion is a function of income.
Models such as Andreoni’s and our own examine the initial reporting
decision as well as the response to an amnesty. Alternatively, as in Alm and
Beck (1986) and Joulfaian (1989) one might focus solely on the response to
an amnesty conditional on the initial reporting decision. These authors
examine models in which the amount of unreported income is already given
and the taxpayer must decide how much of his income to report in an
amnesty. These models can perhaps best be interpreted as follows. The
taxpayer chooses an initial level of income to report, and now faces an
unanticipated change in an important parameter such as the probability of
detection. As a consequence, earlier reporting decisions are no longer optimal
and should be revised if possible. Such models are helpful in understanding
the response to amnesties, but they are of less value in helping us understand
the way people might incorporate the possibility of a future amnesty in their
decision to report income initially.
Since there are several alternative ways of thinking about amnesties, it is
important to ask if our model captures the important elements of the
problem. Unfortunately, there is no direct empirical evidence to resolve this
issue; in particular, there are no surveys of people who participated in
amnesties. There is, however, some casual evidence. Officials involved in the
Maryland amnesty have told us that they believe that a guilty conscience is
often the key factor in the decision to take advantage of an amnesty. News
reports tell a similar story. A divinity student in California went to a state
tax office on the day he was to be ordained; he needed, he said, to clear up
his earthly obligations before he took his heavenly vows.19

“Andreoni gives the deductible on accident insurance as an example of such a shock.

“Business Week, 10 March 1986.
44 AS. Malik and R.M. Schwab, Economics of tax amnesties

There is also some indirect evidence. Fisher, Goddeeris and Young (1989)
present a very interesting profile of people who participated in the Michigan
amnesty. They found that a large majority (72 percent) filed amnesty returns
for only a single year. The last year eligible for the Michigan amnesty was
1984; 53 percent of those tiling amnesty returns filed only for years prior to
1984. In other words, many people had decided to file honestly before the
amnesty was announced.
We would argue that these results are inconsistent with a view that people
participate in amnesties because they believe the chance they will be caught
will be greater after the amnesty; as we noted above, increased enforcement
efforts are typically announced in conjunction with an amnesty. If this view
were correct, then we would expect that most people who come forward
during an amnesty had cheated consistently over a number of years; that is,
they would not have changed their behavior until they were convinced the
chance of being caught had changed. But this is not the case. Typically,
people reported additional income only for a single year, and in a majority
of cases had already decided to begin to report all income voluntarily before
the amnesty was announced. It is consistent, however, with a view that
people take advantage of amnesties because they had found that, for a given
probability of detection, the cost of cheating was less than the benefit.
It is difficult to evaluate the Andreoni (1988) argument that income shocks
are the key factor in amnesties. Fisher, Goddeeris and Young (1989) found
that amnesty participants look very much like other Michigan taxpayers in
terms of income, occupation, age, and number of exemptions. We might
reasonably expect that the probability of an income shock is correlated with
these variables (for example, self-employed people are more likely to have a
substantial income shock than other employed people). To the extent that
this conjecture is correct, the Michigan results do not offer much support for
the income shock argument, though admittedly the evidence is not com-
pletely convincing.

6. Summary and conclusions

This paper examined some of the economic implications of tax amnesties.

We began the analysis by arguing that amnesties are irrelevant in the
standard tax-evasion model. In that model, consumers would never take
advantage of an opportunity to report additional income during an amnesty
because the amount they reported initially would still be optimal.
We then turned to a model based on Cyert and DeGroot’s (1987) adaptive
utility framework. In this model, consumers are not certain about the
disutility from tax evasion when they tile their tax returns. If they later learn
that they would like to be more honest than they have been, an amnesty
 AS. Malik and R.M. Schwab, Economics of tax amnesties 45

gives them an opportunity to report additional income. Thus, everyone gains

from an amnesty, in the sense that those who participate are made better off,
and the government collects additional revenue.
We also showed that amnesties have costs. In particular, we showed that
as the probability of an amnesty rises, people report less income. Thus, an
optimal collection policy requires the government to balance the cost of lost
tax revenues against the gains from an amnesty.
There are a number of ways to extend this research. For instance, our
model does not capture all of the advantages and disadvantages of tax
amnesties. For example, as Leonard and Zeckhauser (1987) suggest, amnes-
ties might actually improve future compliance because people will no longer
be forced to continue to evade in order to hide past evasion; they may also
ease the transition to a new regime of harsher enforcement; on the other
hand, they may anger honest taxpayers. Based on admittedly anecdotal data,
it seems likely to us that this last argument will be particularly important in
the debate over tax amnesties; no one wants to feel foolish for having paid
their taxes if it turns out there was no gain from having done so.
The argument over tax amnesties would also benefit from some empirical
work. As we noted earlier, more than 25 states have offered or authorized
tax amnesties in recent years. Potentially, these experiments offer us the data
to begin to answer some important questions. Who participates in amnesties?
Why do people take advantage of amnesties? Will people report less income
in the future if we offer an amnesty now?

Appendix

Written out in full, the relevant first-order conditions for the taxpayer’s
problem are

(1--@M-(1 -P)~~‘(wo)+P(f-~)~‘(w,)l

+(I -@[-(I -p)tu’(w(J+p(f-t)u’(w,)] =o, (A.11

(A.9

where wg=y-tr*, w1= wo -f(Y - r*), x0 - t(r* + s”), and x1 =x0-

f(y- r* -s”). Note that s”, the additional income reported during an
amnesty, does not appear in the first-order condition for r*, (A.l). This
implies that the comparative static results for r* can be derived by treating
the taxpayer’s decision problem as one that contains a single decision
variable, r*.
It is evident from (A.2) that the value of s” does depend on that of r*, but
46 A.S. Malik and R.M. Schwab, Economics of tax amnesties

it does so in a very simple manner since Lb”/&-* = - 1. The comparative static

derivatives for s” are therefore also easy to derive.

A.1. Changes in evasion

Differentiating (A.l), the effect of a change in the audit probability on the

amount of income reported initially is given by

-(l-‘%)8[u’(wrJt+u’(w,)(f-t)]
ar*
-=- -(I-e)[u’(w&+u’(w,(f-t)]
64.3)
dP (1 -cr)BV(r*)+(l -O)U”(r*) ’

Since both the numerator and denominator of the above expression are
negative, &*/ap>O: increasing the probability of an audit raises the amount
of income reported initially.
The effect on the additional income reported during an amnesty is given

aso - [o’(x& + o’(x,)(f- f)] dr*

(A.4)
ap V”( r* + s’) ap

The first term in this expression captures the direct effect of an increase in p
and is positive. The second term captures the indirect effect, via r*, and is
also positive. Thus, the amount of additional income reported during an
amnesty may rise or fall in response to more frequent auditing. Note,
however, that the total amount of income reported, r*+s’, will always rise
since a(r* + s”)/dp is equal to the first term in (A.4).
The effect of a higher tax rate on the amount of income reported initially
is given by

+(l -cz)Q[-(1 -p)tu”(w,)+p(f-t)v”(w,)]r*

+((l -a)HV”(r*)+(l -fl)U”(r*)). (‘4.5)

Although the first two terms in the numerator of this expression are positive,
the last two terms could be negative, hence the effect of a higher tax rate is,
in general, ambiguous. However, as we demonstrate below, if the taxpayer
 AS. Malik and R.M. Schwab, Economics of tax amnesties 47

displays non-decreasing absolute risk aversion and absolute risk aversion is

higher with u than with u, then the last two terms in (A.5) are non-negative,
which ensures that dr*/dt < 0.
Let Rj( .) denote the taxpayer’s index of absolute risk aversion with utility
function j (j = u, u). Substituting - v’( .)R,( .) for u”( .) and - u’( .)R,( .) for u”( .),
the last two terms in the numerator of (A.5) become

-(I -O-(1 -p)to’(wo)R,(wo)+p(f-t)u’(w,)R,(w,)lr*

41 -Q-(1 +~(f-tt)u’(w,)R,(w,)lr*.
-_p)tu’(wdR,(wo) (A4

Given non-decreasing absolute risk aversion, R,(w,) 2 R,(w,) and R,(w,) 2

R,(w,), while greater absolute risk aversion with u(.) implies that R&w,)2
R,(w,) and R,(w,)~R,(w,). These inequalities together with (A.l) imply that
(A.6) is non-negative.
The effect of a higher tax rate on the additional income reported during an
amnesty is given by

as”
at

C-(1 --Pb’(%) +Pu’(wl)l

.__ +[-(l-p)tu”(w,)+p(f-t)u”(w,)](r*+s”) dr*
- at. (A.7)
V”(r* + s”)

Once again, because of the opposing direct and indirect effects, the sign of
this derivative is ambiguous. However, 8(r* + s”)/& which is equal to the first
term in (A.7), is negative if the taxpayer displays non-decreasing absolute risk
aversion.

A.2. Welfare changes

The effect of a higher audit probability on the taxpayer’s welfare is

obtained by differentiating the maximized value of the objective function,
w*(a, P, t). *’ This yields:

F=(l -@[u(w1)-u(wo)]+(l -cc)B[u(w,)-u(w,)]

+ - u(xo)l.
~~CU(X,) (A4
*‘%nce s”=O at an optimum, W*(a,p, t) reduces to (1 -fI)U(r*)+(l -a)BV(r*)+aOV(r*+s”)
48 AS. Malik and R.M. Schwab, Economics of tax amnesties

Since w1 < w0 and x1 <x0 all three terms in (A.8) are negative, therefore
raising the probability of an audit unambiguously reduces the taxpayer’s
welfare.
The effect of a higher tax rate on the individual’s welfare is given by

aW*
---= -(l-Q[(l-p)u’(w,)+pu’(w,)]r*
at

-(l -a)e[(l-p)v’(w,)+pu’(w,)]r*

-cr@(l -p)u’(x,)+pu’(x,)](r* +s”). (A.9)

All three terms in this expression are negative, so raising the tax rate also
reduces the taxpayer’s welfare. If we let i denote total reported income and 1
denote the taxpayer’s marginal utility of income, (A.9) can be written in the
following more compact form:

aw*
=- E(@. (A.lO)
at

The expectation in (A.10) is taken over all three sources of uncertainty:

honesty, amnesty, and auditing. Thus, r” is equal to (r* +s”) with probability
a0 and to r* with probability (l-4). x takes on one of six different values.
For example, if the taxpayer’s utility function is revealed to be u and there is
an amnesty but no audit, A= u’(x& the probability 1 takes on this value is
a0( 1 -p). If an audit is conducted, x=u’(xJ and the associated probability is
c&p. The marginal utilities of income for the remaining outcomes are defined
similarly.

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