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Financial Contracting with Tax Evaders

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  • Meyer-Brauns, Philipp

Abstract

This paper derives the optimal financial contract when a borrowing entrepreneur can evade taxes in a model of costly state verification. In contrast to previous literature on costly state verification and financial contracting, we find that standard debt contracts are not optimal when tax evasion is possible. Instead, the optimal contract is debt-like only for very low and very high profit realizations, and features a constant repayment and verification of returns in an intermediate range. This occurs because the entrepreneur has to be given a positive rent even under verification in order to not abuse her limited liability protection for excessive tax evasion activities.

Suggested Citation

  • Meyer-Brauns, Philipp, 2014. "Financial Contracting with Tax Evaders," VfS Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100524, Verein für Socialpolitik / German Economic Association.
  • Handle: RePEc:zbw:vfsc14:100524
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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