Constrained Efficient Fine-Cum-Tax Rate Structures : The Case of Constant Relative Risk Aversion

This paper explores the possibility that fines and tax rates impose different welfare costs on different types of taxpayer, so that the government may want to apply different fine/tax rate treatments to different types of taxpayer. Under the assumption that taxpayers exhibit constant relative risk aversion, we characterize the constrained Pareto-efficient fine/tax rate structure, showing that: (i) the co-existence of compliers (the above-ground economy) and evaders (the underground economy) is typical at the Pareto optimum, and (ii) Pareto efficiency requires compliers to face tax rates no higher and fines no lower than those faced by evaders