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Optimal self-employment income tax enforcement

Author

Listed:
  • Bigio, Saki
  • Zilberman, Eduardo

Abstract

Most models of optimal income tax enforcement assume that income is either random or solely remunerates labor, neglecting that auditing strategies may depend on observable inputs. This paper outlines a model to optimally monitor self-employed entrepreneurs when, in addition to reported profits, the tax collection agency also observes the number of workers employed (or any other input variable) at each firm. We show that, by conditioning the monitoring strategy only on labor input, it is optimal for the IRS to audit firms in a way that generates some empirical regularities, like the missing middle. We also show that the optimal direct mechanism can be implemented by an indirect monitoring strategy that is consistent with actual IRS practices. In particular, the IRS calculates inputted income as function of labor. Whenever an entrepreneur reports profits that are lower than inputted income, she is randomly monitored. Finally, we formalize a model of optimal presumption taxation, in which inputted income is the tax base, to compare revenue collection across tax systems.

Suggested Citation

  • Bigio, Saki & Zilberman, Eduardo, 2011. "Optimal self-employment income tax enforcement," Journal of Public Economics, Elsevier, vol. 95(9), pages 1021-1035.
  • Handle: RePEc:eee:pubeco:v:95:y:2011:i:9:p:1021-1035
    DOI: 10.1016/j.jpubeco.2010.06.011
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    Citations

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    Cited by:

    1. Aljoša Feldina & Sašo Polanec, 2012. "Underreporting and Minimum Wage," LICOS Discussion Papers 32412, LICOS - Centre for Institutions and Economic Performance, KU Leuven.
    2. Laszlo Goerke, 2015. "Income tax buyouts and income tax evasion," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 22(1), pages 120-143, February.
    3. Julio Cesar Leal Ordonez, 2014. "Tax collection, the informal sector, and productivity," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(2), pages 262-286, April.
    4. Alvaro Forteza & Cecilia Noboa, 2015. "Tolerance to Tax Evasion," Documentos de Trabajo (working papers) 1015, Department of Economics - dECON.
    5. Alstadsæter, Annette & Jacob, Martin, 2013. "The effect of awareness and incentives on tax evasion," arqus Discussion Papers in Quantitative Tax Research 147, arqus - Arbeitskreis Quantitative Steuerlehre.
    6. Eduardo Zilberman, 2016. "Audits or Distortions: The Optimal Scheme to Enforce Self-Employment Income Taxes," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 18(4), pages 511-544, August.
    7. repec:nea:journl:y:2017:i:33:p:12-27 is not listed on IDEAS
    8. Wu T.C. Michael, 2016. "Profit Tax Evasion under Wage Bargaining Structure," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 16(2), pages 817-834, June.
    9. Casey B. Mulligan, 2017. "The Employer Penalty, Voluntary Compliance, and the Size Distribution of Firms: Evidence from a Survey of Small Businesses," NBER Working Papers 24037, National Bureau of Economic Research, Inc.
    10. Leal-Ordoñez Julio C., 2014. "The informal sector in contemporary models of the aggregate economy," Working Papers 2014-24, Banco de México.
    11. repec:eee:jmacro:v:53:y:2017:i:c:p:107-126 is not listed on IDEAS

    More about this item

    Keywords

    Optimal auditing; Tax evasion; Informal sector; Missing middle; Entrepreneurship; Presumptive taxation;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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