Internal Control vs External Manipulation: A Model of Corporate Income Tax Evasion
Academia Sinica - Research Center for Humanities and Social Sciences; National Taiwan University - Department of Economics
C. Y. Cyrus Chu
Academia Sinica - Institute of Economics
RAND Journal of Economics
The purpose of this paper is to 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 it risk being detected by the tax authorities but, more importantly, the optimal compensation scheme offered to the employees will 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 expense of the risk of being detected, but also in the efficiency loss of internal control.
Number of Pages in PDF File: 25
Keywords: tax evasion, internal control, incomplete contract, contract enforcement, renegotiation
JEL Classification: D0, D7, D8, H2, K4, L2Accepted Paper Series
Date posted: December 17, 2002
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