2]([Delta]) denote the proportion of type 1 and 2 people who dissemble on their income reports, respectively.
1]) that reported truthfully, minus the expected uncollected tax revenue from taxpayers who dissemble, plus the expected net-of-seizure cost penalty revenue, minus the auditing cost c([Delta]) (where c(0) = 0, c[prime]([Delta]) [greater than] 0 and c[double prime]([Delta]) [greater than] 0).
The third and fourth components of (4) give the effect of individuals' self-selections to dissemble.
2]), fewer type 2 taxpayers dissemble on their income report.
Second, with a greater penalty, fewer bankruptcy type 1 individuals will dissemble on their income reports.
The first problem is false claims of potential bankruptcy by taxpayers, and the second problem is that more taxpayers will dissemble if the opportunity to renegotiate the penalty is recognized in advance (a form of moral hazard problem).
As a result, even taxpayers with large psychic costs may be induced to dissemble.
When the opportunity for renegotiation is recognized in advance, expected uncollected tax revenue increases since more tax payers dissemble.