Book Reviews 1 707

laws. However, the authors also conclude that deregulation has not caused
safety problems, They also make reference to the need for efficient pricing
and investment in highways. This is drawn from Small, Winston, and Evans’
recent book Road Work [1989].
In Chapter 6, the authors conclude that no major policy changes need be
recommended. The existing gains should be preserved. Only if things don’t
improve in railroading should we separate operations and right-of-way own-
ership.
This is a good book, investigating the impact of surface freight deregula-
tion. Precise impact numbers are hard to come by. The authors have done a
credible job in documenting the significant gains of deregulation.
W .BRUCE ALLEN is Professor o f Public Policy and Management and Transpor-
tation at The Wharton School, University of Pennsylvania.

REFERENCES
Allen, W. B., A. Preechemetta, G . Shao, and S. Singer (1990), “The Impact of State
Economic Regulation of Motor Carriage on Intrastate and Interstate Commerce.”
Report for the U .S. Department of Transportation, Washington, DC.
Delaney, R. (1987), “The Disunited States: A Country in Search of an Efficient Trans-
portation Policy.” No. 84. (Washington,DC: Cat0 Institute of Policy Analysis).
Small, K., C . Winston, and C. Evans (1989), Road Work: A N e w Highway Pricing and
Investment Model (Washington,DC: The Brookings Institution).

Tasneem Chipty and Ann Dlyden Witte

Cheating the Government: The Economics of Evasion, by Frank A. Cowell.
Cambridge, MA: MIT Press, 1990, 267 pp. Price: $19.95 cloth.
Frank Cowell’s work provides an extended discussion of tax evasion and
the “black economy” and develops a number of microeconomic models that
seek to explain why people evade taxes. He carefully defines evasion and
reflects on the impact of an underground economy, particularly when it is
productive, on evasion. Cowell presents a standard model of the interaction
of the legal private sector, the underground economy, and the public sector
in a framework of risky decisionmaking. He extends this model in various
directions and proceeds to examine how evasion behavior changes as policies
regarding tax rates, audit rates, and penalties alter. Cowell also considers
what might be the optimal policy regarding evasion, using a principal-agent
model of taxpayer-tax agency.
Cowell usefully and interestingly extends the type of models that domi-
nated the tax compliance literature before 1986. He extends the type of ex-
pected utility model pioneered by Allingham and Sandmo [1972], the dual
economy model of Sandmo [19811, and the principal-agent model of
Reinganum and Wilde [1985]. Thus, Cowell’s book can be seen as pushing
these paradigms to their logical conclusion and tying up loose ends. How-
ever, the book is not at the forefront of thinking about tax evasion. For
example, it does not consider the role of tax practitioners or the difficult
708 1 Book Reviews

issues that arise when attempting to develop and estimate empirical models
of tax evasion. The book contains, however, an insightful and well-written
development of ideas fundamental to understanding the economics of tax
evasion. It is perhaps too technical for the layperson, though we do recom-
mend it to students of economics interested in an application of standard
arguments employed in risky decisionmaking models and to those interested
in a rigorous overview and extension of ideas that have dominated tax com-
pliance research until the mid-1980s.
In Cowell’s basic model, the taxpayer knows government policy (i.e., the
tax rate, the penalty rate, and the probability of audit) and treats the evasion
decision as a pure gamble. Taxpayers choose the level of evasion that maxi-
mizes their expected utility from evasion. The government has a budget
constraint that it must satisfl. At this and a number of other points, it is clear
that Cowell does not model the institutional structure of the U.S. or many
other developed countries. It would be interesting to know which economy
his “stylized facts” reflect.
In the model, individuals assume that their actions cannot affect the total
amount of revenue collected by the government, yet their actions do have a
significant impact on their individual utilities. If the government does not
provide a public good, then the taxpayer’s problem is unaltered by the gov-
ernment’s revenue requirement, and Cowell’s model is identical to the pio-
neering model presented by Allingham and Sandmo. If the government does
provide a public good, then the level of public good enters the individuals’
utility function and the individuals’ decisions are affected by the presence of
the public sector. In Cowell’s basic model, the government does provide a
public good.
In this framework, the individual’s level of evasion decreases with in-
creases in both the probability of audit and the penalty for evasion. The
individual’s level of evasion also increases with both increases in income and
decreases in the tax rate. The insights of this model are precisely those of
standard economic models of crime and are consistent with empirical find-
ings, with the exception of the effect of the tax rate on compliance. Empirical
studies suggest that an increase in the tax rate results in an increase in
evasion, while this model suggests the opposite. Cowell, realizing this dis-
crepancy, notes that his approach “may well be incomplete.” This unex-
pected theoretical result has been noted by a number of researchers, and it is
a shame that Cowell does not develop a model that yields a result consistent
with both intuition and empirical findings.
Under Cowell’s model, the aggregate level of evasion in an economy de-
creases with increases in the probability of audit and the penalty for evasion.
The effect of the tax rate on the aggregate level of evasion is ambiguous;
changes in the tax rate affect not only the wealth level of the taxpayers but
also the level of public good provided by the government. A decrease in the
tax rate might make the individual wealthier, but the lower level of the
public good might make the individual worse off. In the model without the
public good, a decrease in the tax rate has only the direct wealth effect, and
in that model, a decrease in the tax rate unambiguously raises the level of
evasion in the economy.
Two critical limitations of Cowell’s model arise from the way in which he
represents the probability of audit. In Cowell’s models, the probability of
audit is strictly exogenous; it does not depend on the taxpayer’s behavior.
 Book Reviews 1 709

Further, it is assumed that the taxpayer knows the true probability of audit.
In fact, the probability of audit is far from independent of the taxpayers
reporting behavior in all economies that we have considered. For example, in
the United States, the probability that an individual return is audited is a
function of reported income and other return characteristics. The effects of
changes in policy on the level of evasion are dampened if individual taxpay-
ers believe that they can alter the probability of audit by altering their report
to the tax authority. Also, if the taxpayer is not certain about the probability
of audit, the additional uncertainty about being audited would make the
risk-averse taxpayer more cautious. This cautiousness would also dampen
reactions to changes in policy.
Cowell extends his basic model in several directions. He introduces the
black economy as a productive entity. Individuals first decide how to divide
time between labor and leisure; then, they decide how to allocate time be-
tween the legal and the black economy. Cowell finds that as the probability of
audit and the penalty for evasion increase, people switch from the black to
the legal sector. Also, as the tax system becomes more progressive, the size of
the black sector increases as a share of the total labor supply.
Finally, Cowell introduces into his model the taxpayer’s fear of the social
stigma associated with being exposed as a tax evader. He allows the individ-
ual’s utility level to be an increasing function of total economy-wide evasion.
He argues that as total evasion increases, the embarrassment of the label
“tax evader” diminishes and the costs involved with finding crooked tax
advice diminish as well. Cowell develops a model with identical taxpayers
who choose between reporting nothing or reporting everything. In the ab-
sence of a publicly provided good, Cowell’s model predicts that aggregate
evasion will either be prevalent or scarce. If most people are cheating, then
everyone will cheat, since fear of social embarrassment is low and costs of
cheating decrease; conversely, if few are cheating, then no one will cheat.
Though he does not develop the extension, Cowell expects to find similar
“clumping” behavior with heterogeneous taxpayers who choose to report
income from a range of reporting levels. In the presence of a publicly pro-
vided good, this model predicts that if taxpayers conform to what other
taxpayers are doing, an increase in conformity reduces the equilibrium level
of evasion.
While the emphasis on social stigma is interesting, Cowell’s method of
introducing it and his results are not very satisfying. In the United States and
a number of other countries, the results of most tax cases are never made
public. Thus, social stigma of the type described by Cowell is unlikely to be a
very powerful force. Perhaps it would be better to talk of social mores and
conformity rather than social stigma.
After completing his exploration of the effect of tax rates, penalties, and
audits on taxpayer behavior, Cowell proceeds to ask what level of evasion
governments should seek. He argues that evasion is a mechanism through
which individuals can overcome distortionary taxation. Hence, the social
value of reducing evasion is ambiguous. Cowell uses a well-known modeling
technique, referred to as mechanism design, to determine the optimal proba-
bility of audit, the tax rate, and the penalty rate.
Cowell finds that the government should choose the probability of audit
that equates the marginal benefit from enforcement to the marginal resource
cost. He argues that traditional cost-benefit analysis has considered marginal
710 / Book Reviews

benefit only in terms of dollars recovered from audit. Cowell’s approach

defines marginal benefit. more broadly: marginal benefit equals marginal
dollar benefit plus the direct and indirect impacts on individual welfare that
arise from forcing the individual to report more honestly. Cowell also finds
that the conventional optimal tax rate should be modified in response to
leakages in the economy through tax evasion. He notes that it is not optimal
to impose a fixed penalty, but rather the penalty rate should be related to the
amount of evaded taxes.
In summary, Cowell very thoroughly explores the implications of quite
simple models of tax compliance. His work is thoughtful and broader in
perspective than is traditional. However, his work has several limitations.
First, he fails to extend any of his theoretical models into testable, empirical
specifications. The empirical results he refers to at various points in the book
are reduced form effects of various tax instruments on the reporting decision.
The game-theoretic models Cowell presents in his book imply a strong struc-
tural model for the interaction between the government and the taxpayers.
Reduced-form estimations provide no insights regarding the parameters of
the structural model. Compliance researchers have acknowledged the short-
comings of such reduced-form estimates and have already moved on to esti-
mating structural models. Cowell does not acknowledge this movement or
use his considerable talents to move research forward in this area. With the
increasing availability of data for compliance research, such advancement is
very important.
In addition, Cowell makes no mention of the role of the tax practitioner in
tax compliance. More than half of all returns in the U.S. are prepared by tax
practitioners. In other countries (e.g., Australia) the proportion of return
prepared by practitioners is even higher. Empirical research has found that
returns prepared by tax practitioners have higher levels of unreported in-
come than those prepared by the taxpayers themselves. In an attempt to
better understand compliance, much current work seeks to model the three-
way interaction between the taxpayer, tax practitioner, and the tax author-
ity.
A final, both unfortunate and disturbing shortcoming of the book is the
author’s use of exclusively male language. Women are referred to in the book
in three instances: once as “whores,” another time in reference to “women’s
work in the house,” and yet a third time as wives who “provide secretarial
service” for their husbands. Our observation of women is that, like men, they
pursue a large range of complex and sophisticated roles.
Cheating the Government is a well-written introduction to the black econ-
omy and a number of models of tax compliance. As such, it will appeal to
someone with good economics training seeking a quick way to understand
some of the major issues and methods of compliance research. However, the
book will be of limited interest to those currently involved in compliance
research and to those with limited knowledge of economic modeling tech-
niques. Many of Cowell’s extensions and conclusions can be found scattered
in existing tax literature. While it is certainly useful to pull these insights
together, it is disappointing that Cowell does not push further in his model-
ing and, perhaps more importantly, does not draw out the insights of the
models he develops for empirical work.
 Book Reviews 1 71 1

TASNEEM CHIPTY is a National Science Foundation Fellow in the Department

of Economics, MIT.
ANN DRYDEN WITTE is Professor of Economics at Wellesley College.

REFERENCES
Allingham, M. and A. Sandmo (1972), “Income Tax Evasion: A Theoretical Analysis,”
Journal of Public Economics 1, pp. 323-338.
Reinganum, J. F. and L. L. Wilde (1985), “Income Tax Compliance in a Principal-
Agent Framework,” Journal of Public Economics 26, pp. 1-18.
Sandmo, A. (198 l ) , “Income Tax Evasion, Labour Supply and the Equity-efficiency
Tradeoff,”Journal of Public Economics 16, pp. 265-288.

David G. Mathiasen

Groups That Work (and Those That Don’t): Creating Conditions for Effective
Teamwork, edited by J. Richard Hackman. San Francisco, CA: Jossey-Bass,
1990, 512 pp. Price: $39.95 cloth.

In the fall of 1981, a staff group in the budget review division of the Office
of Management and Budget (OMB) was following fast-paced action by the
Congress on thirteen appropriation bills. The stakes were high. The president
had threatened to veto appropriations that exceeded his limits. Setting these
standards and monitoring fell to the OMB Director David Stockman. The
task of the scorekeeping team (as it was called) was interpreting 600 or so
budget accounts, both in terms of the total money being appropriated and in
terms of the first-year cash outlay. It wasn’t an easy job, especially as the
results were needed quickly. In 1981 it turned out to be impossible.
If these events had been filmed, we could flash forward to December 22,
1987, a few weeks after the October 19 stock market crash, when the Dow
Jones average fell 22.6 percent in one day. As a response to the crash, the
Congress and the president had again agreed on totals €orappropriation bills
as part of a budget agreement. OMB once again had a group tracking the
details of this legislative action. In the early hours of December 22, a final bill
was passed. The budget director had arranged for a 1 P.M. meeting with the
president to inform him whether the agreed upon targets had been met. A
few minutes before that meeting, the team informed the budget director that,
yes, indeed, the appropriations were on target.
If you asked various individuals involved why the first group failed and the
second succeeded, chances are you would get a variety of answers: “better
training,” “computer systems,” “high morale,” “good leadership.” In fact,
the objective setting of both teams was remarkably similar. The members
were different but drawn from the same pool of talent. The task was almost
identical, the time pressures similar, the leadership basically unchanged.
The difference was managerial change. The successful team of 1987 was well
staffed and well trained. It had the information system it needed. Expecta-
tions and goals were clear. Rewards were reasonably generous and fair.
While members often worked as individuals, coaching and other assistance
were readily available.