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Financial Contracting with Tax Evaders

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  • Philipp Meyer-Brauns

Abstract

This paper derives the optimal financial contract when an entrepreneur can evade taxes in a model of costly state verification. In contrast to the previous literature, 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.

Suggested Citation

  • Philipp Meyer-Brauns, 2014. "Financial Contracting with Tax Evaders," Working Papers tax-mpg-rps-2014-01, Max Planck Institute for Tax Law and Public Finance.
    • Handle: RePEc:mpi:wpaper:tax-mpg-rps-2014-01
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    References listed on IDEAS

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    More about this item

    Keywords

    financial contracting; security design; corporate tax evasion; costly state verification;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G3 - Financial Economics - - Corporate Finance and Governance
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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