Journal Article

Tax Riots

Marco Bassetto and Christopher Phelan

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 75, issue 3, pages 649-669
Published in print July 2008 | ISSN: 0034-6527
Published online July 2008 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2008.00484.x
Tax Riots

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This paper considers an optimal taxation environment where household income is private information, and the government randomly audits and punishes households found to be underreporting. We prove that the optimal mechanism derived using standard mechanism design techniques has a bad equilibrium (a tax riot) where households underreport their incomes, precisely because other households are expected to do so as well. We then consider three alternative approaches to designing a tax scheme when one is worried about bad equilibria.

Keywords: H21; H26

Journal Article.  9994 words.  Illustrated.

Subjects: Taxation, Subsidies, and Revenue

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