| K. L. Glen Ueng, National Chi Nan University C. C. Yang, Academia Sinica |
| Pareto Efficient Fine-cum-Tax Rate Structures: The Case of Constant Relative Risk Aversion |
| Session: C-12-14 Wednesday 16 August 2000 by Yang, C. C. |
| In contrast to the previous tax evasion literature that focuses on properties of optimal audit strategy as opposed to those of optimal tax schedule, this paper studies properties of optimal fine schedule as opposed to those of optimal tax schedule. We consider a model in which taxpayers differ not only in income but also in terms of the probability of evasion detection. The fine-cum-tax rate structure in the model serves as a device for the uninformed tax authority (principal) to distinguish, or screen, informed taxpayers (agents). Under the assumption that taxpayer preferences exhibit constant relative risk aversion, we characterize the Pareto efficient fine-cum-tax rate structure and show that a fine-cum-tax rate structure is Pareto efficient only if tax rates are non-increasing while fines are non-decreasing in the probability of evasion detection; in particular, Pareto efficiency requires that tax payers who comply face tax rates no higher and fines no lower than those who do not. We also show that, within the Pareto efficient fine-cum-tax rate structure, variations in fines have to do with the "equality/inequality" issue. |