The Trade-Off Between Tax Administration and Tax Compliance

David A. Weisbach

Abstract

This paper revisits optimal tax enforcement policy, focusing on two elements of that policy: (1) the optimal mix of government-level tax administration and individual-level tax compliance; and (2) the optimal mix of this combination (together, tax enforcement) and tax rates. The standard view is that we should weight tax administration but not tax compliance by the government’s cost of funds because we must pay for tax administration, but not compliance, through disorting taxes. As a result, we might want to rely on tax compliance measures even when using tax administration would otherwise be less expensive. Using a flexible model that allows the costs of tax ad-ministration and compliance to be imposed in arbitrary ways, I find instead that we should choose between administration and compliance costs purely on effectiveness grounds, without weighting. The reason is that tax administration and tax compliance impose equivalent types of costs and distortions. Both required forced exactions. Using this result, I derive a formula for the optimal mix of tax rates and the overall level of enforcement. Finally, I briefly comment on how the analysis may change in a redistributive income tax context.