Restricted competition as a reward for public service. The case of auditors

The main purpose of this paper is to offer a new insight into the problem of rationalizing governmental regulation in the form of protection to particular professions that fulfil auditing or attestation functions. Protection takes the form of licensing exams, restrictive advertising, price-fixing arrangements, etcetera. The basic new idea is that by providing third parties with excess profits, and then threatening to revoke licenses of third parties that 'misbehave', the government can fulfil its administrative roles more efficiently. We demonstrate this argument by analyzing a stylized tax evasion game with three types of agents: the government, taxpayers, and auditors. Within our framework, we show that by providing auditors with excess profits, and then threatening to revoke licenses of auditors caught abetting tax evasion, the government can keep taxpayers honest with a low audit rate.