OPTIMAL DESIGN OF PERFORMANCE-BASED REWARDS IN TAX ADMINISTRATION

Abstract

This paper illustrates some of the positive incentive effects of rewarding tax performance outcome indicators. By rewarding total collections, the government induces the autonomous tax administration to exert effort in improving the quality of tax enforcement. Improvements in quality effort, in turn, may increase the efficiency of both auditing of underreporters and inspecting of nonfilers. Although audits of underreporters and inspections of nonfilers are substitutes for each other, at least one of these enforcement quantities is necessarily positively related to enforcement quality. We also find that, under some reasonable circumstances, tax evasion falls with either an improvement in the computerization of the tax administration or an increase the highest income tax rate.