Bayer, R.- C. and F. A. Cowell - DARP

1 IntroductionThe behaviour of …rms is sometimes glossed over in the economic analysis oftax policy. In the analysis of tax compliance it is often omitted altogether.This omission is rather odd: tax inspectors typically use background knowledgeabout markets and industries in order to re…ne the monitoring andauditing process and, even if this knowledge is exercised in rule-of-thumbfashion, one would expect it to be in conformity with rational economic principles.Of course, …rms do make an appearance in the standard complianceliterature, but only in a rather specialised manner and in connection withrather specialised questions. In this paper we take a step toward a richeranalysis.What makes the tax-compliance problem di¤erent for …rms or corporationsin contrast to individual taxpayers? There are two main areas ofdi¤erence: (1) the nature of the internal organisation of corporations thatmay a¤ect important aspects of their external activity including tax reporting(Crocker and Slemrod 2005, Chen and Chu 2005), (2) the nature ofthe …rm’s external activities in the market. This paper concentrates on thesecond of these two areas and focuses on corporate tax-evasion and marketdecisions in an oligopolistic setting. We examine the impact of alternativeaudit rules on receipts from a tax on pro…ts, allowing for both complianceresponses and market responses by the …rms. Why does this alternativefocus make such a di¤erence to the analysis?Most models in the literature focus on a simple proportionate auditrule in an adapted version of the Allingham and Sandmo (1972) model, asthough …rms habitually play the dual roles of producers and gamblers. 1 Inmany of the standard models of corporate compliance there is a fundamentalseparation result between the production and concealment activities. Thisconclusion appears to be robust to alternative assumptions about marketstructure and the speci…cations of …rms’objectives. However, taxes are notneutral in a setting where the behaviour of the tax authority depends on allthe declarations in a particular market. The tax authority can exploit thismarket-based information and so, in the light of this, we investigate the implicationsof using a more intelligent audit rule that is easily implementable.Speci…cally we focus on a relative audit rule –where the probability of auditof a particular …rm depends on that …rm’s observable behaviour relative toothers operating in the same market. 21 See Nur-tegin (2008) and Slemrod (2004) for recent overviews of the literature.2 This type of audit rule and the associated compliance behaviour has been examinedin the laboratory (Alm et al. 1993, Clark et al. 2004, Collins and Plumlee 1991). In order1