Mechanism Design with Auditing and Avoidance: Tax Evasion Story

26 Pages Posted: 30 Sep 2022

See all articles by Petteri Palonen

Petteri Palonen

University of Helsinki - Helsinki Graduate School of Economics

Teemu Pekkarinen

Massachusetts Institute of Technology (MIT)

Date Written: September 26, 2022

Abstract

We consider a principal-agent model where the agent is a taxpayer and the principal is a tax authority. The principal wants to know the agent’s private information (e.g. emission or income) so that she can then assign a tax to the agent. It is mandatory for the taxpayer to report his information to the tax authority. Furthermore, the tax authority can investigate whether the taxpayer's report was truthful. If the taxpayer is caught for misreporting, then he is punished by an exogenous fine. We assume that the taxpayer can engage in avoidance activities that undermine the tax authority's audit efforts and, thus, reduce the probability of being caught for lying. We find that in addition to information rent, it is optimal for the tax authority to give the taxpayer 'avoidance rent'.

Keywords: Mechanism Design, Verification, Enforcement, Auditing, Avoidance, Fines, Tax Evasion

JEL Classification: D82, D86, L51

Suggested Citation

Palonen, Petteri and Pekkarinen, Teemu, Mechanism Design with Auditing and Avoidance: Tax Evasion Story (September 26, 2022). Available at SSRN: https://ssrn.com/abstract=4230382 or http://dx.doi.org/10.2139/ssrn.4230382

Petteri Palonen (Contact Author)

University of Helsinki - Helsinki Graduate School of Economics ( email )

P.O. Box 17 (Arkadiankatu 7)
Helsinki, FI00014
Finland

Teemu Pekkarinen

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

HOME PAGE: http://www.teemupekkarinen.com

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