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Income Tax Compliance: the No-Commitment Game

Author

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  • Hindriks, J.

Abstract

We consider a tax enforcement game in which the fiscal authority cannot pre-commit to an inspection policy and its interaction with the taxpayer is modelled as a signalling game. We extend earlier work by allowing for imperfect auditing, non-linear taxation and non-linear penalties. Using the incentive compatibility approach in signalling games (Mailath, 1987) and making explicit out-of-equilibrium beliefs, we demonstrate that the separating equilibrium is the only equilibrium of this game. As for characterisation, we show that the game has a simple solution which displays a constant level of non-compliance, constant audit rates and a progressive bias in the sense that the distribution of true liabilities Lorenz-dominates the distribution of effective tax payments. We also study the impact on the equilibrium outcome of small changes in taxation, penalty, auditing quality and cost of audit. Lastly, we allow for the possibility that the taxpayer is intrinsically honest with some probability and show that a small change in this probability has significant effects on reporting behaviour, audit policy and expected revenue.

Suggested Citation

  • Hindriks, J., 1999. "Income Tax Compliance: the No-Commitment Game," Discussion Papers 9919, University of Exeter, Department of Economics.
    • Handle: RePEc:exe:wpaper:9919
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    Cited by:

    1. Marisa Ratto & Thibaud Verge, 2002. "Optimal Audit Policy and Heterogenous Agents," The Centre for Market and Public Organisation 02/054, The Centre for Market and Public Organisation, University of Bristol, UK.
    2. Hsiao‐Chi Chen & Shi‐Miin Liu, 2008. "Incentive Contracts Under Imperfect Auditing," Manchester School, University of Manchester, vol. 76(2), pages 131-159, March.
    3. Wane, Waly, 2000. "Tax evasion, corruption, and the remuneration of heterogeneous inspectors," Policy Research Working Paper Series 2394, The World Bank.
    4. Hsiao-Chi Chen & Shi-Miin Liu, 2009. "An emission tax pollution control system with imperfect monitoring," Environmental Economics and Policy Studies, Springer;Society for Environmental Economics and Policy Studies - SEEPS, vol. 10(1), pages 21-40, March.
    5. Amitrajeet A. Batabyal & Hamid Beladi, 2010. "A Theoretical Analysis of Income Tax Evasion, Optimal Auditing, and Credibility in Developing Countries," Journal of Theoretical Politics, , vol. 22(1), pages 123-133, January.

    More about this item

    Keywords

    TAXATION ; INCOME ; ASYMETRIC INFORMATION;
    All these keywords.

    JEL classification:

    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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