Public Finance, 2nd Edition

received from mean attitudinal income levels across the respondents so they

are comparable.

The next step in the methodology is to propose a utility function whose

arguments are the individual's earnings capacity after tax and standardized

mean attitudinal utility income. PPH chose the Leyden Welfare Function of

Income (Ability) for the utility function.

29

The Wnal step is to use the utility function to design tax schedules on

earnings capacity according to standard ability-to-pay sacriWce principles.

PPH chose four sacriWce principles: (1) absolute equality of utility, (2) equal-

ity of marginal utilities, (3) equal proportional sacriWce, and (4) equal abso-

lute sacriWce.

The most surprising result of this exercise is that the diVerences between

the respondents' actual and optimal tax payments were fairly small, with the

biggest diVerences arising from the equal marginal utility principle. The main

advantage from taxing abilities in this manner is to eliminate discrepancies

among people with equal earnings capacities.

The methodology of PPH is a reasonable way to proceed to design a tax

on ability, and they suggest various ways of improving the estimates of

earnings capacities. Even so, the idea seems politically infeasible. In our

view, the main value of their exercise is to underscore the likelihood that

existing broad-based taxes will always be distorting. One especially uncom-

fortable implication of their approach is that a person's lifetime tax liability is

at least partly determined by an IQ test taken as a youngster, whatever other

adjustments PPH propose for the equation that estimates earnings capacity.

TAX EVASION

Private information raises the possibility of tax evasion, a problem that

plagues all the developed nations. The IRS estimated in 1987 that 20% of

the tax liability under the federal personal and corporate income taxes went

uncollected.

30

Tax experts and economists distinguish between tax avoidance and tax

evasion. Tax avoidance refers to taxpayers taking advantage of the provisions

of the tax laws to reduce their tax liability, such as arranging to take income in

the form of lightly taxed capital gains or untaxed fringe beneWts rather than

as fully taxed wages and salaries. Avoiding taxes is legal and its consequences

29

The Leyden Welfare Function is a log-normal distribution function of the log diVerence

between the individual's after-tax earnings and standardized mean attitudinal utility income,

divided by the standard deviation of the attitudinal utility income over its six categories of

incomes. The standard deviation is set equal to the sample average standard deviation and

therefore assumed to be constant across individuals.

30

The estimate was reported in J. Slemrod, ``Optimal Taxation and Optimal Tax Systems,''

Journal of Economic Perspectives, Vol. 4, No. 1, Winter 1990, pp. 152±178.

512 TAX EVASION