A General Characterization of Optimal Income Taxation and Enforcement
This paper develops a general approach to characterizing optimal income tax enforcement. Our analysis clarifies the nature of the interplay between tax rates, audit probabilities, and penalties for misreporting. In particular, it is shown that for a variety of objective functions for the principal the optimal tax schedule is in general concave (at least weakly) and monotonic; the marginal tax rates determine the audit probabilities; and less harsh penalties lead to higher enforcement costs. Our results imply that there exists a tradeoff between equity and efficiency considerations in the enforcement context which is similar to that in the moral hazard context for tax policy.
Revised version. Original dated to March 1992. This is a revised version of Chander and Wilde (1992). We thank Kim Border, Luis Corchon, Rajeeva Karandikar, John Ledyard, Dilip Mookherjee, Ignacio Ortuno-Ortin, Thomas Palfrey, Till Requate and Kunal Sengupta for helpful comments and discussion. We have also benefitted from a seminar presentation at Caltech.
Submitted - sswp791.pdf