IRS AS LOAN SHARK - TAX COMPLIANCE WITH BORROWING CONSTRAINTS

This paper considers a simple dynamic model of tax compliance in which people may face binding borrowing constraints. The model leads to much different conclusions and policy recommendations than static models. In particular, the government cannot generate full compliance by setting the expected value of cheating to be negative. Also, it is possible for the government to set penalties in a way that will increase tax revenue over that of full compliance. The government can increase welfare by playing the role of 'loan shark' to people whose borrowing is constrained on the private market.