Should Tax Informants be Paid? The Law and Economics of a Government Monopsony

Abstract:     
More than 140 years ago, the United States Government began to solicit information about violations of federal tax law. Currently, the Internal Revenue Service (Service) runs two reward programs for tax informants, with rewards of up to 30% of the amounts collected as a result of the information supplied.

This article analyzes the demand for information about tax cheating microeconomically, legally and mathematically. It concludes that the Service is essentially a monopsonist in this market, since almost no one else will pay for such information. This leads to a prediction that the number and quality of tax tips, and the resulting federal revenues, will be maximized if Congress unifies the Service's two reward programs and uses the more generous reward structure of its whistleblower program.

Next, this article analyzes the supply of information about tax cheats. In addition to the overwhelming likelihood that the Service will not pay an informant for her information, she must consider the potentially huge costs of being exposed as a tax informant. This article describes those costs of production and proposes that Congress shift some of them to the Service by waiving federal immunity to the claims of informants for breach of the Service's promises of confidentiality. This article details various federal and state laws, some based on professional rules of conduct, that forbid certain potential tax informants from sharing their information with the Service on pains of disbarment from their professions or imprisonment. This article then proposes a universal standard for such laws and professional rules.

The article also offers suggestions for further research and for legislative and administrative changes that will increase the government's revenues, net of rewards paid, from the program. After concluding, the article provides an Appendix that describes mathematically the supply and demand functions of the market for federal tax informants.

Keywords: Whistleblowers, tax informants, law and economics, tax evasion

JEL Classification: D42, D26, K34, K42, L12

Accepted Paper Series