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Corporate tax evasion with agency costs

  • Crocker, Keith J.
  • Slemrod, Joel

This paper examines corporate tax evasion in the context of the contractual relationship between the shareholders of a firm and a tax manager who possesses private information regarding the extent of legally permissible reductions in taxable income, and who may also undertake illegal tax evasion. Using a costly state falsification framework, we characterize formally the optimal incentive compensation contract for the tax manager and, in particular, how the form of that contract changes in response to alternative enforcement policies imposed by the taxing authority. The optimal contract may adjust to offset, at least partially, the effect of sanctions against illegal evasion, and we find a new and policy-relevant non-equivalence result: penalties imposed on the tax manager are more effective in reducing evasion than are those imposed on shareholders.

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Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 89 (2005)
Issue (Month): 9-10 (September)
Pages: 1593-1610

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Handle: RePEc:eee:pubeco:v:89:y:2005:i:9-10:p:1593-1610
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505578

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  1. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  2. Polinsky, A. Mitchell & Shavell, Steven, 1993. "Should employees be subject to fines and imprisonment given the existence of corporate liability?," International Review of Law and Economics, Elsevier, vol. 13(3), pages 239-257, September.
  3. Guesnerie, Roger & Laffont, Jean-Jacques, 1984. "A complete solution to a class of principal-agent problems with an application to the control of a self-managed firm," Journal of Public Economics, Elsevier, vol. 25(3), pages 329-369, December.
  4. HOLMSTROM, Bengt, . "Moral hazard and observability," CORE Discussion Papers RP -379, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  5. Frank Cowell, 2003. "Sticks and carrots," LSE Research Online Documents on Economics 2046, London School of Economics and Political Science, LSE Library.
  6. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, June.
  7. Joel Slemrod, 1998. "A General Model of the Behavioral Response to Taxation," NBER Working Papers 6582, National Bureau of Economic Research, Inc.
  8. Lacker, J.M., 1989. "Optimal Contracts Under Costly State Falsification," Purdue University Economics Working Papers 956, Purdue University, Department of Economics.
  9. Keith J. Crocker & John Morgan, 1998. "Is Honesty the Best Policy? Curtailing Insurance Fraud through Optimal Incentive Contracts," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 355-375, April.
  10. Roger B. Myerson, 1977. "Incentive Compatability and the Bargaining Problem," Discussion Papers 284, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Allingham, Michael G. & Sandmo, Agnar, 1972. "Income tax evasion: a theoretical analysis," Journal of Public Economics, Elsevier, vol. 1(3-4), pages 323-338, November.
  12. Lee, Kangoh, 1998. "Tax Evasion, Monopoly, and Nonneutral Profit Taxes," National Tax Journal, National Tax Association, vol. 51(n. 2), pages 333-38, June.
  13. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
  14. Kong-Pin Chen & C.Y. Cyrus Chu, 2005. "Internal Control vs. External Manipulation: A Model of Corporate Income Tax Evasion," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 151-164, Winter.
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