Administration and Compliance

Abstract

Assessing howmuch tax people owe and ensuring it is paid is a costly activity for both taxpayers and the government. Yet modern ‘optimal tax theory’ has for the most part ignored these costs and has focused on those created by distorting people’s behaviour (distortion costs). But it is possible to adapt the standard framework to reflect administration and compliance costs, and include real-world features of tax administration such as penalties for tax eva- sion, enquiry rates, and obligations to report information to the tax authority. Part I of this chapter presents a simplified model of this type. The optimal policy is to use a mix of tax instruments determined so that the cost to society of raising an extra pound of revenue is the same for each instrument used. Thiswould give tax instruments that raise revenue relatively efficiently a more prominent place in the tax system than those which raise revenue in a more costly way.