IFS Working Paper (W17/08)

Tax avoidance and optimal income tax enforcement

Date: 07 June 2017
Publisher: The IFS
JEL classification: H26, K42, D82, H21
DOI: 10.1920/WP.IFS.2017.1708

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.