Audit hierarchy in a corrupt administration

Abstract

The present work addresses both issues in the context of income tax evasion. About the first it proves a rather strong result, namely that if rewards are related to the evasion detected by an auditor, then (i) no level of hierarchy, however large, can sustain truth-revealing in the long run, while (ii) no hierarchy is necessary in the short run. About the second issue we claim that (i) truth revealing equilibria can be sustained by tying up rewards to tax collection; and, (ii) there exists a level of hierarchy that maximises government's net revenue. Bribe chains have been formally analysed earlier in Basu, Bhattacharya and Mishra (1992). Our analysis reinforces an important conclusion of that paper that a small reward can stop a large leak through bribes in a bribe chain, because individuals in a chain generally get a small fraction of total bribes. These results contradict the claim by Gangopadhyay, Goswami, and Sanyal (1991) that auditing with only one level of superauditors can generate truth-revealing equilibria. We argue that long-run aspects of the problem were not properly addressed in their argument.