Why Can Modern Governments Tax so Much? An Agency Model of Firms as Fiscal Intermediaries

51 Pages Posted: 18 Aug 2009 Last revised: 5 Aug 2010

See all articles by Henrik Kleven

Henrik Kleven

London School of Economics & Political Science (LSE) - Suntory and Toyota International Centres for Economics and Related Disciplines (STICERD)

Claus Thustrup Kreiner

University of Copenhagen - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Emmanuel Saez

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: August 2009

Abstract

This paper presents a simple agency model to explain why third-party income reporting by employers dramatically improves income tax enforcement. Modern firms have a large number of employees and carry out complex production tasks, which requires the use of accurate business records. Because such records are widely used within the firm, any single employee can denounce collusive tax cheating between employees and the employer by revealing the true records to the government. We show that, if a firm is large enough, such whistleblowing threats will make tax enforcement successful even with low penalties and low audit rates. Embedding this agency model into the standard Allingham-Sandmo tax evasion model, we show that third-party reporting improves tax enforcement if the government disallows self-reported losses or audits such losses more stringently, which fits with actual tax policy practices. We also embed the agency model into a simple macroeconomic growth model where the size of firms grows with exogenous technological progress. In early stages of development, firms are small, tax rates are severely constrained by enforcement, and the size of government is too small. As firm size increases, the enforcement constraint is slackened, and government size is growing. In late stages of development, firm size is sufficiently large to make third-party tax enforcement completely effective and government size is socially optimal.

Suggested Citation

Kleven, Henrik and Kreiner, Claus Thustrup and Saez, Emmanuel, Why Can Modern Governments Tax so Much? An Agency Model of Firms as Fiscal Intermediaries (August 2009). NBER Working Paper No. w15218. Available at SSRN: https://ssrn.com/abstract=1454934

Henrik Kleven

London School of Economics & Political Science (LSE) - Suntory and Toyota International Centres for Economics and Related Disciplines (STICERD) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Claus Thustrup Kreiner

University of Copenhagen - Department of Economics ( email )

Ă˜ster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
Denmark
+45 35 32 30 20 (Phone)
+45 35 32 30 00 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Emmanuel Saez (Contact Author)

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-642-4631 (Phone)
510-642-6615 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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