Welfare-improving tax disputes

Abstract

Tax law is often uncertain. Taxpayers and tax authorities can disagree over the tax position, eligibility for tax incentives, or sufficiency of evidence. Taxpayers can face uncertainty over sanctions when tax position is not sustained. In many jurisdictions uncertain tax position can be disputed in court. In this paper, I present an analysis of tax dispute over uncertain tax treatment of investment in the framework of rent-seeking contest with endogenous prize. I show that in the presence of tax uncertainty, a tax dispute can lead to a net welfare gain despite the litigation costs. These results provide economic efficiency rationale for tax disputes.