Taxation, Corruption and Punishment: Integrating Evolutionary Game into the Optimal Control of Government Policy

Abstract

This work examines the issue of tax evasion through underreporting activity. The associated control problem for reducing the number of dishonest citizens and dishonest officers is explicitly analyzed. It is assumed that the social planner can choose the level of effort in order to control the dynamic system through the use of the specific countries’ characteristics [Formula: see text] and [Formula: see text] (the probability of punishing, respectively, a tax-evading citizen and a dishonest officer), and the level of public financial effort represented by taxation [Formula: see text] as control variables. The model implicitly considers that there is a direct correlation between these characteristics and the efficacy and the commitment of the institutional system in contrasting illegality. Hence, in the analysis, [Formula: see text] and [Formula: see text] are considered as the effective probabilities to be charged the fine. This study supplies a novel approach concerning the dynamic model underlying the optimal control, which is based on the strategic interaction of the economic agents’ choices. These latter are described by an evolutionary dynamic process which is strongly characterized by [Formula: see text] and [Formula: see text]. The analysis supplies a useful policy indication for the social planner in choosing the way to obtain a certain socially desirable target. Moreover, it helps the comprehension of the different corruption and evasion behavior observable in the real world, where countries with similar level of taxation may have different levels of corruption.