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Optimal taxes and penalties when the government cannot commit to its audit policy

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Listed:
  • Leandro Arozamena
  • Martin Besfamille
  • Pablo Sanguinetti

Abstract

We examine the problem of a utilitarian government that sets taxes and fines for evaders but cannot commit to any enforcement policy. Given the tax law, the government and taxpayers —some of whom are honest— play a report-audit game that, depending on taxes, fines and audit costs, generates either full evasion and no audits, or partial evasion and random auditing. Anticipating both possibilities, we characterize the optimal tax law. We show that it may be optimal for the government not to fine evaders as a way to commit not to audit. Moreover, social welfare is nonmonotonic in the audit cost.

Suggested Citation

  • Leandro Arozamena & Martin Besfamille & Pablo Sanguinetti, 2010. "Optimal taxes and penalties when the government cannot commit to its audit policy," Department of Economics Working Papers 2010-10, Universidad Torcuato Di Tella.
    • Handle: RePEc:udt:wpecon:2010-10
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    References listed on IDEAS

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    More about this item

    Keywords

    Tax rates; Tax evasion; Enforcement; Audit costs; No commitment; Mixed-strategy equilibrium.;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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