Optimal Income Tax Enforcement in the Presence of Tax Avoidance


We examine the optimal auditing problem of a tax authority when taxpayers can choose both to evade and avoid. For a convex penalty function the incentive-compatibility constraints may bind for the richest taxpayer and at a positive level of both evasion and avoidance. The audit function is non-increasing in reported income, and is higher for progressive tax functions than for regressive tax functions. Higher marginal tax rates increase the incentives for non-compliance, overturning the well-known Yitzhaki paradox.

The Routledge Companion on Tax Avoidance Research, Ch.22, London: Taylor and Francis