Thursday, March 13, 2014
Mark Phillips (USC) presents Endogenous Detection and Audit Intensity in the Tax Evasion Game at UCLA today as part of its Tax Policy and Public Finance Colloquium Series hosted by Jason Oh, Kirk Stark, and Alexander Wu:
In this paper I introduce an imperfect and endogenous detection technology into the sequential tax evasion game. During a tax agency's examination of a taxpayer, the fraction of evasion detected depends upon three factors: the taxpayer's true income; the taxpayer's unreported income; and the tax agency's exam-specic resources (i.e. intensity of examination). I solve for an equilibrium in which the tax agency chooses both whom to audit and at what intensity subject to an enforcement budget constraint. In contrast to simpler games, the tax agency cannot infer any given taxpayer's true income, even after an audit occurs. Instead, the tax agency need know only two more limited but realistic pieces of information for a given taxpayer: the expected amount of detected (not true) evasion, and how that amount changes with marginal increases in audit intensity.
The paper is organized as follows. Section 2 describes the detection technology function and the role it plays in the objectives of taxpayers and the tax agency. Section 3 solves for the game's equilibrium. Section 4 calibrates the game's parameters to match data on U.S. taxpayers' underreporting as well as IRS tax administration practices. This calibration then serves as a baseline for the dierent detection technology improvement counterfactuals. Section 5 concludes with the paper's policy and tax administration implications as well as suggestions for further research.