|Date:||07 June 2017|
|Authors:||Duccio Gamannossi degl’Innocenti and Matthew D. Rablen|
|JEL classification:||H26, K42, D82, H21|
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.