Taxes and Bribery: The Role of Wage Incentives

The paper explores different models of payment schemes for tax inspectors and takes into account the problem of both moral hazard (arising because taking bribes cannot be observed without costly monitoring) and adverse selection (where not all potential tax inspectors can be identified as being honest or dishonest) related to bribe taking. The authors discuss three wage regimes related to tax inspectors. The first where one could pay the same wage that a tax inspector could earn elsewhere (the reservation wage); the second, where one could pay a wage which solves the moral hazard problem and deter bribery; and the third, where governments could pay a wage below the reservation wage and therefore only the dishonest become tax inspectors.