Decentralized Deterrence, with an Application to Labor Tax Auditing

72 Pages Posted: 4 Apr 2012

See all articles by Edoardo Di Porto

Edoardo Di Porto

University of Naples Federico II - CSEF - Center for Studies in Economics and Finance

Nicola Persico

Northwestern University - Kellogg School of Management

Nicolas Sahuguet

HEC Montreal - Institute of Applied Economics

Date Written: March 2012

Abstract

Deterrence of illegal activities is frequently carried out by many atomistic auditors (tax auditors, law enforcement agents, etc.). Not much is known either normatively about the best way to incentivize atomistic auditors, nor positively about what these incentives actually look like in real world organizations. This paper focuses almost exclusively on the positive question. It proposes a game-theoretic model of decentralized deterrence and an empirical test, based on the equilibrium of the model, to identify the incentives of individual auditors. In the special (but important) case of tax enforcement, the paper fully characterizes the equilibrium of a strategic auditing game and provides a method to calibrate its parameters based on audit data.

Applying the model and method to Italian auditing data provides ‘proof of concept’: the methods are practical and tractable. We are able to provide an estimate of tax evasion based on (non-random) audit data alone. Counterfactual simulation of the model quantifies the costs and benefits of alternative auditing policies. We compare decentralized enforcement with a counterfactual commitment policy, and compute the loss from the former. Thus we are able to quantify the costs of decentralizing enforcement.

Keywords: audits, deterrence, tax evasion

JEL Classification: H26, H83, K42

Suggested Citation

Di Porto, Edoardo and Persico, Nicola and Sahuguet, Nicolas, Decentralized Deterrence, with an Application to Labor Tax Auditing (March 2012). CEPR Discussion Paper No. DP8901. Available at SSRN: https://ssrn.com/abstract=2034119

Edoardo Di Porto (Contact Author)

University of Naples Federico II - CSEF - Center for Studies in Economics and Finance ( email )

Via Cintia
Complesso Monte S. Angelo
Naples, Naples 80126
Italy

Nicola Persico

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Nicolas Sahuguet

HEC Montreal - Institute of Applied Economics ( email )

3000, ch. de la Côte-Ste-Catherine
Montréal, Quebec H3T 2A7
Canada

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