Corporate Income Tax Evasion and Efficiency Loss

Abstract

We set up a model to investigate corporate income tax evasion. The main difference between individual tax evasion and corporate tax evasion is that the owners and the managers of a corporation are usually separate from each other, thus they need to cooperate when deciding to evade, which suggests that corporate tax evasion is a kind of principal-agent problem. Managers need to be given enough incentive to evade through a compensation package depending on the firmâ s after-tax profit rather than before-tax profit. We find that the optimal compensation scheme has to be altered under evasion, which means an evading firm bears an extra cost of efficiency loss in corporate governance in addition to the cost of being detected and penalized compared to an individual, which we believe is an important factor in a firmâ s decision making process and for explaining the great difference in observed data.