Optimal Government Responses to Tax Planning

Abstract:     
Although most individuals recognize the necessity of taxation, few like to pay taxes. Governments face costs to collect taxes; people expend resources to legally avoid taxation. Such expenditure represents social waste, as it is a form of rent-seeking. This gives rise to a modified Samuelson Rule which considers this additional cost of taxation. Since there is a market for tax planning methods, the magnitude of these costs depends on the market structure. We consider how a government might reduce tax planning by creating market inefficiencies or failures. We set forth a formal economic model to identify the optimal amount of tax planning the government should permit, and consider how governmentally-created market failures could be implemented.

Keywords: optimal taxation, tax avoidance, public goods, patents, market failure

JEL Classifications: D42, H21, H26, H30, H41, K10

Working Paper Series