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Delegation as Commitment: The Case of Income Tax Audits

Nahum D. Melumad and Dilip Mookherjee
The RAND Journal of Economics
Vol. 20, No. 2 (Summer, 1989), pp. 139-163
Published by: Wiley on behalf of RAND Corporation
Stable URL: http://www.jstor.org/stable/2555686
Page Count: 25
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Delegation as Commitment: The Case of Income Tax Audits
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Abstract

In this article we study the value of delegating authority over income tax audit policy, arising from the incompleteness of contracts. Consider a utilitarian government whose ability to commit is limited to aggregate dimensions of its audit policy, as publicly verifiable information about detailed allocations of audit budgets is not available. We show that the welfare level associated with the full-commitment solution can be attained by delegating authority over audit policy to a manager. The latter is offered a simple incentive scheme based only on the aggregate variables which are publicly observable. In contrast, if the government retains authority, direct commitment to these same variables does not allow the full-commitment welfare level to be achieved. Thus, despite sharing a common informational basis, delegation may perform better than centralized arrangements in the presence of incomplete contracts.

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