Why Can Modern Governments Tax So Much? An Agency Model of Firms as Fiscal Intermediaries

Abstract

This paper presents a simple agency model to explain why third-party income reporting by employers dramatically improves income tax enforcement. Modern firms have a large number of employees and carry out complex production tasks, which requires the use of accurate business records. Because such records are widely used within the firm, any single employee can denounce collusive tax cheating between employees and the employer by revealing the true records to the government. We show that, if a firm is large enough, such whistleblowing threats will make tax enforcement successful even with low penalties and low audit rates. Embedding this agency model into the standard Allingham-Sandmo tax evasion model, we show that third-party reporting improves tax enforcement if the government disallows self-reported losses or audits such losses more stringently, which fits with actual tax policy practices. We also embed the agency model into a simple macroeconomic growth model where the size of firms grows with exogenous technological progress. In early stages of development, firms are small, tax rates are severely constrained by enforcement, and the size of government is too small. As firm size increases, the enforcement constraint is slackened, and government size is growing. In late stages of development, firm size is sufficiently large to make third-party tax enforcement completely effective and government size is socially optimal.

Taking the high road? Compliance with commuter tax allowances and the role of evasion spillovers

“…In the spirit of the third-party model proposed by Kleven, Kreiner and Saez (2009), our results underpin that employers need the means as well as the incentive to correctly record taxable items of their workers to be a reliable partner to the government. Specifically, Kleven, Kreiner and Saez (2009) suggest that when it comes to wages, companies have sufficient incentive to keep accurate business records in order to enhance productivity. In a nutshell, it is the existence of such business records evidence that makes third-party tax enforcement so successful.…”

Meet the Oligarchs: Business Legitimacy, State Capacity and Taxation

“…Based on these ideas, The Economist magazine published a "crony-capitalism" index using data on billionaire wealth in sectors where there is a lot of interaction with State (see "Comparing crony capitalism around the world", May 5 th , 2016). 14 The CFA Institute (2016) Gennaioli and Voth 2015) or the size of firms (Kleven, Kreiner, and Saez 2016). There is also work emphasizing the complementarity between State building and good institutions (e.g., Acemoglu 2005;Dinecco 2009).…”

Under the Radar: The Effects of Monitoring Firms on Tax Compliance

“…Recent theoretical studies argue that this can be explained by the additional deterrence effect implied by third-party information reporting (Kopczuk and Slemrod, 2006;Gordon and Li, 2009;Kleven, Kreiner, and Saez, 2015). Indeed, experimental evidence shows that the tax compliance rate on third-party reported income is much higher than on self-reported income (Kleven et al, 2011;IRS, 2012) and that threat-of-audit letters have a significant effect on self-reported tax bases (Slemrod, Blumenthal, and Christian, 2001;Kleven et al, 2011;Pomeranz, 2015).…”