The Optimum Quantity of IRS Tax Enforcement

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Over on Twitter, Prof. Steven Hamilton posted a short thread on calculating the optimum quantity of IRS tax enforcement.  The complete thread is below.

Prof. Steven Hamilton The Optimum Quantity of IRS Tax Enforcement

Prof. Steven Hamilton

Prof. Hamilton raises two points.

First, the optimum quantity of enforcement does not collect 100% of tax revenue.  As always, the optimum quantity equates marginal benefit with marginal cost.  The marginal benefit is $1 more of tax revenue.  The marginal cost is the value of the resources the IRS expends to collect that revenue.  Unless marginal collection costs are zero, the optimum quantity will be less than 100% of total possible tax revenue.

But Prof. Hamilton’s second point is that using the marginal value is incorrect since that is simply a transfer.  Instead we should use the social value of the marginal revenue.  He states this is an order of magnitude less than the actual tax revenue.  He’s the expert; I have no reason to doubt this claim.

Translating his two points into my example, $1 of additional tax revenue has a social value of about $0.10.  The IRS should use that figure when calculating the optimal quantity of enforcement.

Prof. Hamilton is assistant professor at The George Washington University.  His Ph.D. is from the University of Michigan (Public Policy and Economics).  I look forward to more of his exceptionally clear writing and thinking.

Here’s the complete thread:

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About Tony Lima

Retired after teaching economics at California State Univ., East Bay (Hayward, CA). Ph.D., economics, Stanford. Also taught MBA finance at the California University of Management and Technology. Occasionally take on a consulting project if it's interesting. Other interests include wine and technology.