Internal Control vs. External Manipulation: A Model of Corporate Income Tax Evasion

Kong-Pin Chen and C.Y. Cyrus Chu ()
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C.Y. Cyrus Chu: Academia Sinica

RAND Journal of Economics, 2005, vol. 36, issue 4, 151-164

Abstract: We offer a formal model of corporate income tax evasion. While individual tax evasion is essentially a portfolio-selection problem, corporate income tax evasion is much more complicated. When the owner of a firm decides to evade taxes, not only does she risk being detected by the tax authorities, more importantly, the optimal compensation scheme offered to the employees will also be altered. Specifically, due to the illegal nature of tax evasion, the contract offered to the manager is necessarily incomplete. This creates a distortion in the manager's effort and reduces the efficiency of the contract. Tax evasion thus increases the profit retained by the firm not only at the risk of being detected, but also at the cost of efficiency loss in internal control.

Date: 2005
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