Auditing ghosts by prosperity signals

Abstract

Ghosts are economic agents who evade taxes by failing to file a return. Knowing nothing about them, the tax agency is unable to track them down through audit strategies which are based on reported income. The present paper develops a simple model of the audit decision for a ghost-busting tax agency which bases its audit strategy on signals of prosperous living, such as ownership of high-quality housing. Ghosts have a preference for high-quality housing, but may opt to own houses of a lower quality so as to escape detection. The paper compares the optimal audit rules and net tax collection under signal and blind auditing of the non-declaring population, deriving conditions under which each strategy will dominate the other.