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Internal Control vs External Manipulation: A Model of Corporate Income Tax Evasion

25 Pages Posted: 17 Dec 2002  

Kong-Pin Chen

Academia Sinica - Research Center for Humanities and Social Sciences; National Taiwan University - Department of Economics

C. Y. Cyrus Chu

Academia Sinica - Institute of Economics

Abstract

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.

Keywords: tax evasion, internal control, incomplete contract, contract enforcement, renegotiation

JEL Classification: D0, D7, D8, H2, K4, L2

Suggested Citation

Chen, Kong-Pin and Chu, C. Y. Cyrus, Internal Control vs External Manipulation: A Model of Corporate Income Tax Evasion. RAND Journal of Economics. Available at SSRN: https://ssrn.com/abstract=353860 or http://dx.doi.org/10.2139/ssrn.353860

Kong-Pin Chen (Contact Author)

Academia Sinica - Research Center for Humanities and Social Sciences ( email )

RCHSS
Academia Sinica
Nankang, Taipei, 11529
Taiwan
886 2 2789 8160 (Phone)
886 2 2785 4160 (Fax)

HOME PAGE: http://idv.sinica.edu.tw/kongpin/

National Taiwan University - Department of Economics

21 Hsiu Chow Rd
Taipei, 10020
Taiwan

C. Y. Cyrus Chu

Academia Sinica - Institute of Economics ( email )

128 Academia Road, Section 2
Nankang
Taipei, 11529
Taiwan

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