Delegation as Commitment: The Case of Income Tax Audits

By Nahum MelumadDilip Mookheijee
1988| Working Paper No. 933

We study the value of delegating authority over income tax audit policy, arising from incompleteness of contracts. Suppose a utilitarian government’s ability to commit is limited to aggregate dimensions of its audit policy, as publicly verifiable information about detailed allocations of audit budgets are not available. We show that if the government retains authority over those allocations, it cannot usually attain the welfare level associated with the full-commitment solution. However, it can achieve this welfare level by delegating authority to a manager, who is motivated by a simple incentive scheme based only on aggregate dimensions of audit performance.