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Tax competition with evasion

Author

Listed:
  • Nestor Gandelman

    (Universidad ORT Uruguay. Facultad de Administración y Ciencias Sociales. Departmento de Economía)

  • Rubén Hernández-Murillo

    (Federal Reserve Bank of St. Luis)

Abstract

This paper examines a multicommunity environment with competition among local governments for tax base. Local governments can verify whether agents pay taxes or not buy can only imperfectly monitor where contributions are made. Individual agents enjoy the local public good, but may decide to cheat and pay tazes not in their place of residence, saving the tax difference. The cheating decisions of individual agents is analyzed. The Nash equilibrium of the game with symmetric and non-symmetric communities is characterized. If communities are identical the equilibrium must be symmetric. When communities differ in size, smaller communities have stronger incentives to lower their taz and attract agents from neighboring communities. In equilibrium smaller communities set lower taxes. If communities differ in income distribution there are two opposing effects. Decreasing taxes may attract neighbors, increasing the tax base (stealing effect). But if local agents do not tend to take chances, increasing tazes even at the cost of reducing the tax base may increase total revenue (captive effect). The overall effect is ambiguous. Finally, the optimal monitoring policy of a high tax community is characterized.

Suggested Citation

  • Nestor Gandelman & Rubén Hernández-Murillo, 2000. "Tax competition with evasion," Documentos de Investigación 7, Universidad ORT Uruguay. Facultad de Administración y Ciencias Sociales.
    • Handle: RePEc:avs:wpaper:7
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