The Political Economy of the (Weak) Enforcement of Sales Tax

30 Pages Posted: 18 Feb 2009

See all articles by Martin Besfamille

Martin Besfamille

Instituto de Economía, Pontificia Universidad Católica de Chile

Philippe De Donder

University of Toulouse 1 - Toulouse School of Economics (TSE)

Jean-Marie Lozachmeur

University of Toulouse 1

Date Written: January 2009

Abstract

The objective of this paper is to understand the determinants of the enforcement level of indirect taxation in a positive setting. We build a sequential game where individuals differing in their willingness to pay for a taxed good vote over the enforcement level. Firms then compete à la Cournot and choose the fraction of sales taxes to evade. We assume in most of the paper that the tax rate is set exogenously. Voters face the following trade-off: more enforcement increases tax collection but also increases the consumer price of the goods sold in an imperfectly competitive market.

We obtain that the equilibrium enforcement level is the one most-preferred by the individual with the median willingness to pay, that it is not affected by the structure of the market (number of firms) and the firms' marginal cost, and that it decreases with the resource cost of evasion and with the tax rate. We also compare the enforcement level chosen by majority voting with the utilitarian level. In the last section, we endogenize the tax rate by assuming that individuals vote simultaneously over tax rate and enforcement level. We prove the existence of a Condorcet winner and show that it entails full enforcement (i.e., no tax evasion at equilibrium). The existence of markets with less than full enforcement then depends crucially on the fact that tax rates are not tailored to each market individually.

Keywords: imperfect competition, intermediate preferences, majority voting, Tax evasion

JEL Classification: D43, D72, H26, H32

Suggested Citation

Besfamille, Martin and De Donder, Philippe and Lozachmeur, Jean-Marie, The Political Economy of the (Weak) Enforcement of Sales Tax (January 2009). Available at SSRN: https://ssrn.com/abstract=1345634

Martin Besfamille (Contact Author)

Instituto de Economía, Pontificia Universidad Católica de Chile ( email )

Casilla 76
Correo 17
Santiago
Chile
++56 2 2354 7105 (Phone)

Philippe De Donder

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

Jean-Marie Lozachmeur

University of Toulouse 1 ( email )

Place Anatole France
Toulouse Cedex, F-31042
France

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