Dynamic history-dependent tax and environmental compliance monitoring of risk-averse firms

Firms may misreport income or fail to comply with environmental regulations. Under dynamic history-dependent compliance monitoring (Landsberger and Meilijson 1982), penalties or monitoring frequency are selected on the basis of recent compliance history. Explicit solutions under given monitoring costs and income distributions are presented, using a commonplace utility-penalty scenario under which firms never comply fully with regulations if statically monitored (regardless of their income distribution), but find it to their benefit, if dynamically monitored, to comply fully when their income is sufficiently high. Dynamic monitoring is typically superior even when constrained to monitor all firms at rates below the optimal static rate. The model is applied to actual IRS 2010 tax-report monitoring and compliance data partitioned by income bracket.

Joint with Noam Goldberg and Yael Perlman.