The Penalty for Tax Evasion when Taxes are set Optimally

Pierre Pestieau, Uri Possen and Steven Slutsky
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Uri Possen: Cornell University
Steven Slutsky: University of Florida

No 1994016, LIDAM Discussion Papers CORE from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE)

Abstract: This paper considers why limited penalties are used to punish tax evaders. The basic model has all individuals drawing an income from the same random distribution. The individuals must decide whether to report thruthfully or understate their incomes. Two types of individuals exist who differ in either their degree of risk aversion or their initial wealth endowment. The government chooses tax rates, audit probabilities, and penalties for evasion to maximize an expected ex post social welfare function. Penalties are at their upper bound if individuals feel unlimited harm from such penalties or if the optimum has everyone reporting thruthfully. However, when the maximum penalty inflicts limited harm, it can be optimal to have some individuals falsely report and have the penalty less than its upper bound.

Date: 1994-03-01
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Persistent link: https://EconPapers.repec.org/RePEc:cor:louvco:1994016

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