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Financial Contracting with Tax Evaders

26 Pages Posted: 7 Jan 2014 Last revised: 18 Jan 2014

Philipp Meyer-Brauns

Max Planck Society for the Advancement of the Sciences - Max Planck Institute for Tax Law and Public Finance

Date Written: January 7, 2014

Abstract

This paper derives the optimal financial contract when an entrepreneur can evade taxes in a model of costly state verification. In contrast to previous literature on costly state verification and financial contracting, we find that standard debt contracts are not optimal when tax evasion is possible. Instead, the optimal contract is debt-like only for very low and very high profit realizations, and features a constant repayment and verification of returns in an intermediate range. This occurs because the entrepreneur has to be given a positive rent even under verification in order to not abuse her limited liability protection for excessive tax evasion activities.

Keywords: Financial Contracting, Security Design, Corporate Tax Evasion, Costly State Verification

JEL Classification: D82, D86, G3, H25, H26

Suggested Citation

Meyer-Brauns, Philipp, Financial Contracting with Tax Evaders (January 7, 2014). Working Paper of the Max Planck Institute for Tax Law and Public Finance No. 2014-01 . Available at SSRN: https://ssrn.com/abstract=2375604 or http://dx.doi.org/10.2139/ssrn.2375604

Philipp Meyer-Brauns (Contact Author)

Max Planck Society for the Advancement of the Sciences - Max Planck Institute for Tax Law and Public Finance ( email )

Marstallplatz 1
Munich, 80539
Germany

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