Rewards Versus Penalties: on a New Policy against Tax Evasion

Abstract

The theoretical analysis of tax evasion has typically concentrated on the role of Abstract penalties and on the probability of being investigated and penalized. This article introduces into the standard model of tax evasion the possibility of pecuniary rewards as an economic incentive for taxpaying. The analysis shows that introducing a reward for payment of taxes leads to a welfare improvement over non-prohibitive penalty regimes. An optimal penalty-reward mix is derived that guarantees a certain tax yield for the government and, at the same time, maximizes the taxpayer's utility.