Dynamic income tax enforcement

Abstract

In this paper, we are concerned with one simple objective: how should income tax enforcement be designed when people's incomes evolve over time stochastically? This we formalize with a two-period model. Income tax audit can condition not only on current period's reported income, it can go back to past income reports. Because there is likely to be correlation of incomes across periods, it makes sense to enrich audit strategies. But then the tax payer's reporting strategy will also alter, it must be a best response, in an inter-temporal manner, to the audit strategy.