An Optimal Conviction Policy for Offenses that May Have Been Committed by Accident

Abstract

When the tax authorities discover that a taxpayer has failed to report a certain part of his income, they cannot tell whether this is the result of deliberate tax evasion or, perhaps, the result of an innocent oversight. Penalties must be designed so as to apply whenever misreporting is discovered, but society may very well wish to distinguish between a deliberate offense and an offense that has been committed by accident and to be more lenient in the latter case. However, leniency will encourage people to commit the offense deliberately. In a one-shot game, equilibrium consists of society picking severe penalties and innocent offenders being hit hard. However, in the repeated game, there exists an equilibrium in which the optimal penalties imposed by society on people with a "reasonable" record are lenient and the optimal strategy for the individuals is to refrain from deliberate offenses.