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As a tax consultant to the Government of your country, you have been asked to estimate an empirical model on the demand for income tax evasion...

      

As a tax consultant to the Government of your country, you have been asked to estimate an empirical
model on the demand for income tax evasion (ITE) in the country. You think true income (TI),
Marginal tax rate (MTR), penalty rate (PR) and probability of detection (PROB) will be important
variables. Using national time-series annual data from 1967 to 1995, you estimate the following
regression equation:
ite1012019.png
The calculated t – statistics are reported in parentheses, and figures are in shillings.
Required:
i) Write down the population theoretical empirical model on the demand for income tax evasion
(ITE).
ii) Provide a theoretical justification of the empirical model specification in (i) above, that is, expected
signs of the regression coefficients and why.
iii) Interpret the constant term (-52.59), coefficient for true income (33.44) and coefficient of
probability of detection (-1.48) in the context of the problem.
iv) Before collecting data, the principal tax collector and her staff believed that penalty rate had a
negative influence on income tax evasion and should therefore be used as leverage on those who
evade tax.
From the regression results, should this be the case? Why?
(Note: critical t-value = - 1.701 at 0.05 level of significance)

  

Answers


Raphael
The regression line will be:
i) ITEt=-52.59-0.20PRt-1.48PROBt
ii) For any coefficient of the independent variables that is above the t value at o.o5 significance level is
eliminated.
Note: This should not be followed as a rule generally. Here it has been used since there in no
much information about the standard error of regression and the correlation coefficient. Otherwise
the main aim is to include the variables that give the least standard error and highest coefficient of
determination.
iii) The –52.59 constant term indicates that people usually pay up their taxes without evading. The
33.44 coefficient of true income indicated that people would tend to evade tax more when their
income is increased. The –1.48 coefficient of probability of detection indicates that people will tend
to reduce evasion when they realize there are higher probabilities of being detected.
iv) From the regression results, it is true, that it had a negative influence on income tax evasion.

raphael answered the question on January 10, 2019 at 12:18


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