Taxes and Bribery: The Role of Wage Incentives

This paper presents a simple model to evaluate alternative payment schemes for tax inspectors in the presence of corruption. The authors consider problems of both moral hazard, whic h arises because taking bribes cannot be observed without costly monitoring, and adverse selection, since not all potential tax inspectors can be identified as being honest or dishonest. The autho rs identify three wage regimes. First, one could pay the same wage that a tax inspector could earn elsewhere--his reservation wage. Second, one could pay a wage which solves the moral hazard problem, i.e. deters bribery. This they call an efficiency wage, by analogy with recent models examined in macroeconomics. Third, the government could pay a wage below the reservation wage, at which onl y the dishonest become tax inspectors--the capitulation wage. The authors make precise the conditions under which each yields the greatest amount of tax revenues, net of administrative costs. Copyright 1993 by Royal Economic Society.