On the Budget-Constrained IRS: Equilibrium and Equilibrium and efficiency

This paper extends Graetz, Reinganum and Wildes (1986) seminal work on tax compliance to the real-world scenario where the IRS (Internal Revenue Service) faces a budget constraint imposed upon her by the Congress. The paper consists of two parts. The first part is positive we characterize the equilibria resulting from the interaction between taxpayers and the budget-constrained IRS. The second part is normative - we examine the effeciency implication of varying the size of the budget allocated to the IRS. It is shown that, to mitigate or eliminate the so-called congestion e¤ect, the IRS should be sufficiently budgeted and, in particular, we provide a case for the policy prescription that the size of the budget allocated to the IRS should be expanded as long as an additional dollar allocated could return more than an additional dollar of tax revenue.