Enforcement Costs and the Optimal Progressivity of Income Taxes

Abstract

Mirrlees, Sheshinski, Atkinson, Feldstein, Stern, Hellwig, and others have analyzed the balance between redistribution and production of income in setting marginal tax rates. These studies indicated that the trade-off would resolve to optimal marginal tax rates substantially below 100 percent. Recently, attention has turned to the effect of marginal tax rates on evasion (Townsend; Sandmo; Graetz and Wilde; Mookherjee and Png, 1989a; Sanchez and Sobel). In this line of work, a revenue collector can enforce compliance with tax law by expending resources to audit taxpayers' reports. The more progressive the income tax, however, the more tempted will a taxpayer be to evade, and hence the more auditing will be required to