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Tax Riots

  • Marco Bassetto
  • Christopher Phelan

This paper considers an optimal taxation environment where household income is private information, and the government randomly audits and punishes households found to be underreporting. We prove that the optimal mechanism derived using standard mechanism design techniques has a bad equilibrium (a tax riot) where households underreport their incomes, precisely because other households are expected to do so as well. We then consider three alternative approaches to designing a tax scheme when one is worried about bad equilibria. Copyright 2008, Wiley-Blackwell.

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File URL: http://hdl.handle.net/10.1111/j.1467-937X.2008.00484.x
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Article provided by Oxford University Press in its journal The Review of Economic Studies.

Volume (Year): 75 (2008)
Issue (Month): 3 ()
Pages: 649-669

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Handle: RePEc:oup:restud:v:75:y:2008:i:3:p:649-669
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  1. Ennis, Huberto M. & Keister, Todd, 2005. "Optimal fiscal policy under multiple equilibria," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1359-1377, November.
  2. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  3. Mikhail Golosov & Aleh Tsyvinski, 2005. "Designing Optimal Disability Insurance: A Case for Asset Testing," Levine's Bibliography 784828000000000450, UCLA Department of Economics.
  4. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," Review of Economic Studies, Oxford University Press, vol. 70(3), pages 569-587.
  5. Matthew O. Jackson, 2001. "A crash course in implementation theory," Social Choice and Welfare, Springer, vol. 18(4), pages 655-708.
  6. Krasa, Stefan & Villamil, Anne P, 1994. "Optimal Multilateral Contracts," Economic Theory, Springer, vol. 4(2), pages 167-87, March.
  7. Pesendorfer, Wolfgang & Levine, David & Fudenberg, Drew, 1998. "When Are Nonanonymous Players Negligible?," Scholarly Articles 3203775, Harvard University Department of Economics.
  8. Stefania Albanesi & Christopher Sleet, 2004. "Dynamic optimal taxation with private information," Discussion Paper / Institute for Empirical Macroeconomics 140, Federal Reserve Bank of Minneapolis.
  9. David K. Levine & Wolfgang Pesendorfer, 1995. "When Are Agents Negligible?," Levine's Working Paper Archive 96, David K. Levine.
  10. Huberto M. Ennis & Todd Keister, 2003. "Government Policy and the Probability of Coordination Failures," Working Papers 0301, Centro de Investigacion Economica, ITAM.
  11. Moffitt, Robert, 1985. "Unemployment insurance and the distribution of unemployment spells," Journal of Econometrics, Elsevier, vol. 28(1), pages 85-101, April.
  12. Jackson, Matthew O, 1991. "Bayesian Implementation," Econometrica, Econometric Society, vol. 59(2), pages 461-77, March.
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