Gregory S. Amacher*-Erkki Koskela**-Markku Ollikainen*** ROYALTY REFORM AND ILLEGAL REPORTING OF HARVEST VOLUMES UNDER ALTERNATIVE PENALTY SCHEMES****

Transcription

1 Gegoy S. Amache-Ekki Koskela-Makk Ollikainen ROYALTY REFORM AND ILLEGAL REPORTING OF HARVEST VOLUMES UNDER ALTERNATIVE PENALTY SCHEMES Depamen of Economics, Univesiy of Helsinki Discssion Papes No 562:2003 ISSN IBSN May 21, Depamen of Foesy, College of Naal Resoces, 307 Cheaham Hall, Viginia Polyechnic Insie and Sae Univesiy, Blacksbg, VA 24060, USA. Depamen of Economics, P.O. Box 54 Unioninka 37, FIN Univesiy of Helsinki, Finland, and Reseach Depamen of he Bank of Finland, P.O. Box 160, Helsinki, Finland.. Depamen of Economics and Managemen, P.O. Box 27, FIN Univesiy of Helsinki, Finland. Koskela hanks he Reseach Uni on Economic Sces and Gowh RUESG a he Univesiy of Helsinki fo financial sppo and Bank of Finland fo hospialiy and Ollikainen hanks Academy of Finland fo financial sppo.

2 1 Royaly efom and illegal epoing of haves volmes nde alenaive penaly schemes Absac: We sdy oyaly efom in a famewok whee ax evasion o oyaly non-paymen hogh ndeepoing of havesing is possible, nde wo alenaive penaly schemes. By inodcing a evene-neal change in oyaly pogession o ax egession, we demonsae seveal new findings fo how acal and epoed havesing change. Fis, while highe oyaly ax pogession will always decease acal havesing, is effec on epoed havesing is sensiive o he penaly scheme imposed by he govenmen. If he fine is levied on he evaded oyaly paymens, a ise in evene-neal oyaly ae pogession will incease epoing havesing. B when he fine is levied on ndeclaed havesing, he evese happens hee, a ax-evene neal ise in a lmp-sm oyaly fee will decease illegal epoing of havesing and haves income. Second, independenly of he penaly scheme, an incease in evene-neal ax pogession will decease acal havesing of he concession. The esls ae impoan in evalaing ecen claims made in he foesy lieae egading efom in oyalies fo concessions-based foes economies. Keywods: illegal logging, oyaly pogession, ax evasion, defoesaion. JEL classificaion: D81, H26, 23.

3 2 1. Inodcion In mos of he conies wih opical foess, concessions ae he pimay means by which imbe is sold fom govenmen foess Walke and Smih 1993, Gay Royalies chaged agains havesing of concessions ae vey impoan o govenmen evene collecions Gay 2000, Amache e al Royalies ae ypically applied o haves volmes o vales, and can exis in vaios foms depending on whehe hey ae diffeeniaed o pogessive in ems of ne haves ens. I has been aged ha exising oyaly sysems ae pooly-sed insmens fo eihe collecing govenmen evenes o pomoing ssainable havesing of concessions G e al. 1991, FAO The pimay ciicism is ha oyaly aes ae oo low, poviding lile incenive fo edced havesing of lage concessions, and poviding lile en cape fo he govenmen Gay 2000, Vincen 1990, Bshbacke Govenmens in opical conies also inefficienly enfoce hese ax sysems, so ha lage amons of havess ae no epoed o axing ahoiies. These illegal aciviies fhe edce oyaly evene geneaed by he govenmen and incease ne ens o haveses of concessions ITTO 2002, Repeo and Gillis These ciicisms have spaked discssions of efom of oyalies in many opical foes seings. The discssion has hs fa has no, howeve, acknowledged ha oyalies and govenmen evene collecions ae linked, and ha boh canno be consideed independenly of illegal aciviies sch as excess logging o ndeepoing of haves volmes. High oyalies may appea o be a panacea and a way of inceasing govenmen evenes while cbing excess logging, b hey can also change he incenive fo haveses o chea and aemp o evade he 1 Fo insance, ecen inees in Bazil s new concession plan is moivaed by he need o aise govenmen collecions hogh a oyaly-based chage sysem MMA/PPF Malaysia also has simila ineess FAO 1997.

4 3 oyaly paymens. Cheaing is a well-known vie of concessions when applied in developing conies ITTO The pobabiliy ha haveses can be cagh by he concession-awading govenmen is also a faco in hei illegal aciviy choices. All of his means ha simply calling fo highe oyaly aes is a poblem wih no clea solion. I also means ha efom in any oyaly sysem is no as simple as aising he oyaly ae, like many believe. In his pape, we focs on commonly sggesed oyaly efoms in he lieae, namely sing eihe highe ni o ad valoem oyaly aes fo havesing, o sing a combinaion of a oyaly ae and a lmp sm foes fee o sbsidy applied o concessions ighs fo a discssion of hese sggesed efoms, see e.g. Gay Unlike ohe wok, we invesigae hese efoms nde assmpions ha illegal epoing of havesing migh occ. Ths, we will ake explicily ino accon he ineacion of oyalies, acal havesing, and epoed haves volmes in a concessions seing, whee he govenmen has decided o allocae a concession of a ceain size. Thee is a posiive pobabiliy ha he govenmen can deec cheaing; he pobabiliy level may eflec how efficien he govenmen is in obseving cheaing, o how feqenly he govenmen chooses o adi and enfoce illegal haves epoing. Two ypes of penaly sces ae assmed, fines based on evaded ndepaid oyalies fo havesing, and fines levied agains ndeclaed haves volmes. 2 A fomal model is developed o sdy whehe incenives fo illegal logging and acal havesing can be edced by a efom in oyaly sysems. Given he sggesed combinaion of a fee which cold alenaively be a sbsidy and a ni ad valoem oyaly, a convenional model of ax evasion nde pogessive egessive axaion applies well o o poblem. We analyze he sggesed oyaly efom by changing he oyaly sysems owad geae o lesse pogession o egession, in a manne ha keeps expeced govenmen oyaly evene consan. Wih sch 2 The specificaion of fine sces is naal fo o opical foesy poblem and has sppo in ohe lieae on ax evasion e.g., see Yizhaki 1974 fo penalies levied agains evaded axes and Allingham and Sandmo 1972 fo penalies levied on ndeclaed incomes.

5 4 a policy, an incease in he oyaly ax ae and he ax exempion level o an incease in he lmp fee and a decease in he oyaly ax ae means highe pogession egession, in he sense ha he aveage ax ae inceases deceases moe apidly wih inceases in he axable amon Msgave and Thin We analyze oyaly efom in a manne ha holds expeced oyaly collecions consan. This eqiemen is impoan in poviding he incenive fo a govenmen, ineesed in evene geneaion, o efom oyalies in ways ha poec emaining opical naive foess and also edce illegal havesing behavio. The impoance of ensing evene-sabiliy ding a efom in policies is clea fom he ecen lieae ha esablishes a coelaion beween opical cony deb levels and he aes of defoesaion, o lieae linking oyalies specifically o evene collecion Pooe This pape is he fis o conside oyaly efom nde he possibiliy of illegal epoing of haves levels. While some eseaches have consideed incenives fo illegal logging a he mico havesing level Boscolo and Vincen 2000, Clake e al. 1993, hee is vially no wok ha consides oyaly efom in he pesence of illegal logging, even hogh hee have ofen been calls o aise oyaly aes in he applied lieae. O appoach hee is closes o wok in geneal pblic finance heoy ha consides govenmen ax choices and he poenial fo ax evasion. Mch of his heoy has been developed fo efom in ax sysems whee ax evasion is an endogenos fncion of he ax ae o ax pogession chosen by he govenmen fo sveys of he ax evasion lieae see e.g. Cowell 1987 and Myles We poceed as follows. In secion 2 we pesen he basic famewok, inclding he ime seqence of decisions, penaly schemes and ax pogession feaes of he poblem, and also povide pecsoy compaaive saics of epoed havesing nde alenaive penaly schemes. In secion 3 we examine he elaionship beween a ax-evene neal change in oyaly ax pogession and epoed havesing nde alenaive penaly schemes, while secion 4 epos

6 5 esls concening he effec of oyaly ax pogession on acal havesing. Finally, hee is a bief conclding secion. 2. Basic Famewok We conside a epesenaive concession and havese. The concession exiss a a poin in ime and has aleady been chosen o be a given fixed size. Howeve, he havese can decide how mch of he concession o haves and how mch of an illegal aciviy o engage in. We sdy one of he moe common foms of illegal aciviies associaed wih concessions in pacice, i.e., he ndeepoing of haves volmes by he havese o he govenmen. This is a ciical poblem in opical conies, as i has been ecenly esimaed ha haves volmes ae pecen ndeepoed in many conies ITTO 2002, Gay Time Seqence of Decisions, Royaly Pogession and Penaly Schemes Following he ode of havesing and pocessing, we assme he following ime seqence of decisions, depiced in Fige 1. Fis, he havese deemines he level of acal havesing,, once a concession is awaded by he govenmen. Second, once he havese emoves a given amon of volme, i ms hen decide how mch of his o epo o he govenmen,, heeby deemining wha is oyaly paymen obligaion will eqal. Finally, nceainy egading deecion o non-deecion of cheaing by he govenmen is evealed. If he fim is cagh cheaing, hen penalies ae imposed. The poblem is solved sing backwad indcion. Fige 1: Time seqence of decisions ψ Deecion/non-deecion p

7 6 The havese akes he imbe pice q as given. 3 Also he pobabiliy of deecion by he govenmen p and he fine f will be exogenos paamees fo he havese. The fis assmpion is consisen wih he ypes of small cony conexs whee he poblem of illegal logging is ace. The second assmpion is also naal and consisen wih ohe wok in naal esoce enfocemen Milliman 1986, Sinen and Andeson As he havese ms epo a pa of acal havesing o he govenmen, i can be descibed convenienly by,, 1 whee is he haves level declaed i.e., epoed, is acal havesing wihin he concession, and is he popoion of acal havesing ha is epoed, 0 1. A decease in epesens an incease in oyaly evasion. The govenmen manages he concession and imposes a oyaly agains volme havesed by he fim. The fim pays he oyaly once i havess and declaes epoed haves volme. We assme he following sce fo his volme-based oyaly, 2 whee is he oyaly ae, is he volme of imbe epoed o he govenmen fom concession, and is an exempion level deemined by he govenmen, i.e. he amon of epoed volme no sbjec o he oyaly chage. 4 Noe ha his volme-based oyaly cold easily be given as a vale-based oyaly sing imbe pice and applying he oyaly agains he vale of imbe havesed fom he concession. In pacice oyalies applied o concessions ofen 3 This is he mos common assmpion. An excepion is Maelli 1984, who ses a simple model of monopolisic behavio o sdy he elaionship beween ax evasion and ax incidence. 4 As will be seen lae on, a combinaion of a oyaly ax and a lmp-sm fee yielding a egessive ax sysem can be obained fom 2 by assming ha is negaive and independen of he oyaly ae, so ha ax evene wih epoed havesing is fo he deails, see Appendix 4.

8 7 appea in he fom of 2. 5 The fom in 2 is also convenien in ha i allows s o examine a specific oyaly pogession. 6 Conside ha a simlaneos incease in he ax exempion and he oyaly ax ae is eqivalen o an incease in oyaly pogession, in he sense ha he aveage ax ae inceases moe apidly in he ax base. If he havese is deeced cheaing a fine penaly is imposed. Sppose he govenmen levies he penaly wih a fine ae of f. This fine ae is exogenos and is deemined by laws. I is applied o haveses who ae cagh evading oyaly paymens hogh ndeepoing of havesed volme. 7 We will conside wo alenaive penaly schemes ha cove wo possible infacions involved wih misepoing havess once a cheae is cagh. The fis is a penaly levied agains he amon of he oyaly ha he cheaing havese evades. In his case he penaly is wien f 1. The second is a fine levied agains ndeclaed haves volme, so ha he penaly is wien f 1. 8 The havese s pofis depend on havesing, he illegal aciviy, he pobabiliy of deecion, and he penaly scheme if cagh cheaing. Le q be he imbe pice and C be a convex cos of havesing, i.e., C 0; C 0. 9 Fis, conside he case whee he penaly is levied on he evaded oyaly paymen. If havese is no deeced cheaing, hen is ne ens ae given by 3, b if he cheaing fim is cagh and he penaly is enfoced, hen is ne en is given by 4, 5 This is he case in many opical foes conies, inclding Indonesia, he Philippines, and pas of Lain Ameica Gay 2000, Vincen 1990, Amache e al The oyaly consideed hee is simila in spii o an aea oyaly if we hink of a concession in ems of oal volme of haves in a given aea. In his case, some qaniy of haves volme is sally exemped fom he ax paymen made by he havese. Many concessions have been applied in his manne. 6 Fo a discssion of vaios foms of ax pogession, see he classic pape by Msgave and Thin See also chapes 6-8 in Lambe 1993 fo a fhe analysis. 7 O inclsion of an exogenos fine is consisen wih he obsevaion ha fines ae ypically se by he legal seco. This is a common assmpion in he envionmenal economics lieae whee fines and enfocemen of polling fims ae sdied. 8 The implicaions of hese penaly schemes have been sdied in a diffeen conex by Koskela In wha follows, deivaives of fncions wih one agmen ae denoed by pimes, while paial deivaives of a fncion wih wo o moe agmens ae denoed by sbscips of he paamee we ae diffeeniaing wih espec o.

9 8 Y q C 3 Y f 1 4 The second case, whee he penaly is levied on ndeclaed haves volme, will be denoed sing a spescip. Ths, he ens o he haveses ae given by 5 and 6 fo he cases when he havese is no cagh and is cagh, especively: Y q c 5 Y f 1. 6 Finally, we make he convenional assmpion abo pefeences fo isky behavio by he havese. We assme ha he havese is isk-avese, so ha he maximizes he expeced iliy of haves evene by choosing acal and epoed haves volmes. Amed wih hese definiions and assmpions we now solve he fis and he second sage of he model in he nex wo sbsecions The Choice of Repoed Haves Volme nde he Penaly Scheme Levied on he Evaded Royaly Using backwad indcion, we fis solve he second sage, whee he havese chooses he exen of hei illegal aciviy via he choice of epoed havesing, aking acal havesing fom he fis sage as exogenos. The havese chooses epoed haves volme o maximize expeced iliy, 1 p U Y pu.

10 9 The fis ode condiion fo epoed havesing when he penaly ae f is levied agains he amon of he evaded oyaly paymen is, 1 p U Y p f 1 U 0. 7 A condiion fo an ineio solion, whee he fim does chea, eqies, 1 p U Y p f 1 U 0 1 pf This condiion makes sense, becase if he expeced fine pf wee eqal o one, hen he havese wold no have an incenive o ndeepo haves volmes, and hen 1. Using he fis ode condiion 7, and assming now ha cheaing indeed occs 1, we can show ha an ineio solion eqies he following condiion, p f 1 p U Y 1 U 9 Eqaion 9 shows ha he havese ses he aio of maginal iliies fo cheaing and no cheaing eqal o he expeced fine mins he deecion pobabiliy. The second-ode condiion holds and is given in he Appendix 1. The fis ode condiion fo epoed havesing when he penaly ae f is levied agains ndeclaed havesing is, 1 p U Y p f U 0. 10

11 10 An ineio solion eqies ha, 1 1 p U Y p f U 0 pf 0, 11 which can be inepeed analogosly o eqaion 8. Eqaion 11 eqies ha he expeced fine pf ms be less han he oyaly ae paid by he havese if volme is declaed. If hese ae eqal hen he havese will neve chea. We show in Appendix 1 ha he second ode condiion holds. As a pecso o fhe analysis, we ms deemine how he havese s decision o ndeepo haves volme depends on paamees sch as acal havesing, he oyaly ae, and he oyaly exempion level. A smmay of compaaive saics esls fo hese paamees ae pesened in Table 1 and deived in Appendix 2. As Table 1 shows, in he second sage he solions o 7 and 10 define an opimal choice of oyaly evasion, hogh he choice of epoed havesing, as a fncion of acal haves level in sage 1, he oyaly ae, and he oyaly exempion level,,, and,,. The esls in Table 1 ae paly sensiive o isk avesion behavio. Unde deceasing absole isk avesion DARA and a penaly levied agains he evaded oyaly, epoed volmes incease as eihe he oyaly ae is inceased, acal haves levels incease, o he oyaly exempion Table 1: Compaaive Saics of Repoed Haves Volme Paamee Penaly on Evaded Royaly Penaly on Undeclaed Havesing CARA DARA CARA DARA Royaly Rae /- Royaly Exempion Acal Havesing

12 11 level inceases. These esls ae de o he negaive income effecs of he oyaly ae on epoed haves levels, while he posiive income effec is de o he highe oyaly exempion level. The esls emain qaliaively he same fo he oyaly ae and acal havesing nde consan absole isk avesion CARA, b now he oyaly exempion level has no effec on epoed havesing. Finally, when he penaly is levied on ndeclaed havesing, he effecs of acal havesing and oyaly exempion levels on epoed havesing ae qaliaively simila, b he effec of he oyaly ae is now ambigos. 2.3 The Choice of Acal Haves Volme nde Alenaive Penaly Schemes When choosing he acal level of havesing in he fis sage, he havese akes he opimal vale of epoed havesing as given and maximizes his indiec expeced iliy fncion. When he fine is levied on evaded oyalies expeced indiec iliy is wien, Max 1 p U Y pu, 12 whee denoes an indiec iliy fncion and ψ has been se o is opimal level, ψ, so ha Y and ae given by 2 and 3 wih ψ = ψ. Using he envelope heoem, 10 he fis ode condiion fo 12 becomes, 0 1 p U Y aˆ pu bˆ, 13 ˆ whee a ˆ q C' 0 and b q C' f 1 0. The second ode condiion is given in Appendix Hee, he envelope heoem gaanees ha he indiec effec of havesing vanishes, i.e. 0.

13 12 When he penaly fo cheaing is levied based on ndeclaed havesing, he havese s poblem is o maximize, Max 1 p U Y pu, 14 whee Y and ae defined by 5 and 6 wih ψ = ψ. The fis ode condiion fo he havese s choice is:. The second RHS em is zeo sing he envelope heoem, and hs we can wie, ~ 0 1 p U Y a ~ pu b, 15 ~ ~ whee, a q C' 0 and b q C' f 1 0. The compaaive saics fo acal havesing in ems of he oyaly ae and he oyaly exempion nde he wo alenaive penaly schemes ae deived in Appendix 3 and pesened in Table 2. Table 2: Compaaive Saics of Acal Haves Volme Paamee Penaly on Evaded Royaly Penaly on Undeclaed Havesing CARA DARA CARA DARA Royaly Rae Royaly Exempion In he case of DARA he oyaly ae will have a negaive effec on acal havesing, b he oyaly exempion level will have a posiive effec nde boh penaly schemes. This can be inepeed as follows. Unde DARA he oyaly ae will have a negaive sbsiion and a negaive einfocing income effec, while he oyaly exempion level will have a posiive income

14 13 effec. Unde CARA, he income effecs will vanish so ha he oyaly exempion level will have no effec, b he oyaly ae will have a negaive sbsiion effec. The findings pesened in Tables 1 and 2 n o o be impoan fo o policy efom analysis o follow. The impacs of oyalies and exempion levels on cheaing and acal havesing depend no only on isk pefeences, b also on he nae of penaly schemes. Fo deceasing absole isk-avesion we have Poposiion 1. In he case of DARA, if he penaly ae is levied agains he evaded oyaly paymens, hen a highe oyaly ae edces acal havesing b inceases epoed havesing, hs deceasing illegal aciviies. The effec of he oyaly ae is ambigos when he penaly is levied agains ndeclaed havesing. In boh cases highe oyaly exempion levels incease acal havesing b decease epoed havesing. Ineesingly, highe oyaly aes and oyaly exempions wok in opposie diecions. As we will demonsae in he nex wo secions, hei oveall effecs nde oyaly efom will heefoe depend on he penaly scheme, and someimes b no always one shold se he oyaly fee - insead of a oyaly exempion o incease epoed havesing as he lieae on oyalies sggess. 3. Tax-Revene Neal Royaly Pogession and Repoed Havesing Now we examine he conseqences of alenaive penaly schemes fo oyaly policy efom. Recall o iniial inees was o examine oyaly efom owads pogession egession nde wo condiions, 1 he govenmen is ineesed in evene geneaion and wishes o keep expeced evene collecion consan, and 2 illegal epoing of haves volmes occs and can ndemine govenmen evene collecions. Hence, he specific policy qesion we answe in his secion is: Wha is he effec on epoed havesing of an incease in he oyaly ax ae and

15 14 oyaly exempion, done in a manne ha holds consan expeced oyaly evene collecions of he govenmen? A. Penaly Chaged on Evaded Royaly Paymens The social planne s expeced ax evene, when he penaly ae is levied agains he evaded oyalies, can be wien, R e pf The fis em in backes is he expeced oyaly evene colleced fom epoed havesing, and he second em is expeced evenes deived fom penalies chaged agains evaded haves volmes if he havese is cagh wih pobabiliy p. To examine efom in he oyaly sysem ha holds evene consan we fis oally diffeeniae 16 wih espec o policy insmens and, and epoed havesing, o obain e R d d 1 pf d dr e The oal effec of he oyaly ae and oyaly exempion on epoed havesing can hen be expessed as d d d, 18 Sbsiing d fom 17 ino he RHS of 18 gives he effec of changing oyaly pogession on epoed havesing, holding expeced ax evene consan, d d dr e e R 2 0 [ pf ]

16 15 Fom Table 1, we know ha 0, and a an ineio solion fo epoed havesing, 1-pf > 0 ms hold fom 8. Ths he denominao of 19 is posiive. The nmeao ms be examined moe closely o deemine is sign. Fis we wie he nmeao in ems of absole isk avesion, A. U ''. U '.. Unde DARA, A. 0 and Y > implies AY < A, while nde CARA, A. 0 and AY = A. Using hese definiions, nde DARA he nmeao em is posiive, i.e., R e [ A A Y ] A Y pf 1 A 1 f 1 p [ A Y f 1 A ] Unde CARA, we peviosly showed ha ndeepoing of havesing is no sensiive o he oyaly ae 0, and heefoe eqaion 20 simplifies o, R e pf 1 1 f 1 p f d Rening o 19, we have heefoe shown ha 0. Smmaizing, we have, d Poposiion 2. Unde a penaly scheme whee he fine is chaged agains he evaded oyaly paymens, highe oyaly pogession, implemened o keep expeced oyaly collecions consan, will incease epoed havesing and heeby decease cheaing. e dr 0 The esl in Poposiion 2 shows an ineesing policy esl. The govenmen can edce ndeepoing of haves volmes if oyalies ae efomed owad highe pogession, even when i is done in a manne ha holds govenmen evene collecions consan. Ths, he evene needs of he govenmen and he need o keep cheaing conolled ae compaible wih

17 16 highe pogession nde his penaly scheme. Iniively, when he penaly ae is chaged on evaded oyaly evenes, he oyaly ae and he oyaly ax exempion will indce posiive and negaive income effecs, especively, b he posiive income effec dominaes fo he havese. Ths, he fim facing his ype of penaly will incease epoed havesing, and illegal aciviies will decease. This esl ns cone o he lieae s ecommendaion of sing a combinaion of a foes fee on he concession igh and a oyaly ae. We have shown ha a sbsidy, and no a fee, leading o pogessiviy of he oyaly ae is needed o conol cheaing when he penaly ae is chaged on evaded oyaly evenes. The diffeence in o esl and he ecommendaion fom he lieae is o explici consideaion of cheaing and penaly schemes. B. Penaly Chaged on Undeclaed Haves As above we again en o o policy qesion nde his alenaive penaly scheme: Wha is he effec of a change in ax pogession on epoed havesing, ndeaken in a manne ha holds expeced oyaly collecion evenes consan, when penalies ae levied on ndeclaed havesing? The govenmen s expeced evenes fo his penaly case ae, R e [ pf 1 ]. 21 Taking he oal deivaive wih espec o policy insmens and epoed havesing, in a manne ha holds expeced evene consan, yields d e d [ pf ] d dr 0. 22

18 17 Now he oal effec of he oyaly ae and he oyaly exempion level on epoed havesing can be wien explicily as, d d d 23 Sbsiing he RHS of 22 fo he d em in 23 gives he effec of changing oyaly pogession on epoed havesing, holding expeced ax evene consan, d d e 1 dr [ pf ] 0 24 The denominao of 24 is posiive becase we peviosly showed 0, and we also know ha fo an ineio solion, pf > 0. Concening he nmeao, we can wie i sing compaaive saics and he fis-ode condiion 10, i.e., 1 1 p ' Y pu ' 0 25 d Using 25 in 24, we see ha 0. Smmaizing we have, d e 1 [ pf ] dr 0 Poposiion 3. Unde a penaly scheme whee he fine is assessed agains ndeclaed havesing, highe oyaly pogession, which keeps expeced oyaly collecion evenes consan, will decease epoed havesing and heeby incease cheaing. Poposiion 3 leads o a compleely diffeen conclsion han in he case whee penalies ae levied agains evaded oyaly paymens Poposiion 2. When he penaly ae is chaged on

19 18 ndeclaed havesing volme, an incease in he oyaly ae will indce posiive income and negaive sbsiion effecs on epoed havesing, while he oyaly ax exempion change will indce a negaive income effec. Ths, a ax-evene neal incease in oyaly pogession will have a ne negaive sbsiion effec, heeby inceasing cheaing and ndeepoing of haves volmes fom he concession. Accoding o Poposiion 3, lowe oyaly pogession will incease epoed havesing. This sggess ha a egessive oyaly sysem wih a minimm lmp-sm fee is he pope design o decease cheaing when he fine is assessed agains ndeclaed havesing. We demonsae his fomally in Appendix 4. Ths, his penaly case is now consisen wih he sggesion in he lieae noed ealie egading oyaly efom. 4. Tax-Revene Neal Royaly Pogession and Acal Havesing Mch of he lieae discsses he ole of oyalies in changing acal havesing, i.e., poposing fo insance ha oyalies shold be inceased in ode o edce defoesaion and concession-based haves expansion, o o allow govenmens o cape geae ens fom concession havess. The pevios secion consideed epoed havesing, which is of cose an impoan componen of cheaing and esling penalies. We now focs on incenives concening he havese s choice of acal havesing. Like above we ask he following policy qesion: wha is he effec of a change on oyaly pogession on acal havesing, ndeaken o hold expeced oyaly collecion evenes consan? Again, we conside boh he case of penalies levied on evaded oyalies and ndeclaed havesing. A. Penaly Chaged on Evaded Royalies Expeced oyaly evenes ae now wien as,

20 19 R e [ pf 1 ]. 26 Poceeding as above, we obain, e R d d [ pf 1 1 pf ] d, 27 dr e 0 2 so ha he diffeence hee compaed o he ealie case is ha now we have o conside changes in epoed havesing ha aise fom changes in acal havesing. The oal effec of he oyaly ae and he exempion level on acal havesing is given by he following oal deivaive, d d d 28 Using 27 in 28 gives he effec of changing oyaly pogession on acal havesing, holding expeced oyaly evenes consan, d d dr e e R 2 0 [1 [ 1 pf 1 pf ] 29 The second em in he denominao is posiive becase, as we showed peviosly, 0 and a an ineio solion, 1 pf 0 and pf 1 1 pf 0 becase 0. We conine nde he plasible assmpion ha he oal expession in he denominao is posiive. The nmeao can be expessed as follows,

21 20 R 2 e 1 {1 p U ' Y pu ' 1 f R 1 p U Y aˆ[ A 1 x A Y] 1 p U Y aˆ[ A A Y] e } 30 whee x f 1. Using his definiion and eqaion 26 we can simplify he em in baces o obain, [ 1 p U Y pu 1 ] 0 31 d Now, sing 31 ogehe wih 29, we obain, 0. d e dr 0 We smmaize his in he following: Poposiion 4. Unde a penaly scheme whee he fine is levied agains evaded oyaly paymens, highe oyaly pogession, implemened o keep expeced oyaly collecion evenes consan, will decease acal havesing. Accoding o Poposiion 4 oyaly aes shold be highe if exempions ae also inceased, as long as he objecive is o edce defoesaion and sill keep oyaly evenes colleced by he govenmen consan. This policy package edces acal havesing. The economic inepeaion is saighfowad. A highe oyaly ae has negaive sbsiion and income effecs on acal havesing, while a highe oyaly exempion level, sed o keep ax collecion consan, has a posiive income effec. Ths, if he govenmen keeps expeced oyaly collecion evenes consan, he income effecs vanish and he negaive sbsiion effec emains. Noe also ha if acal havesing ends o be lage han he size of he concession awaded by he govenmen o he havese, i.e., we have anohe fom of illegal logging pesen, hen highe pogession cold be sed o edce i.

22 21 B. Penaly Chaged on Undeclaed Haves Finally, we conside he second ype of penaly scheme. Poceeding as befoe, expeced oyaly collecion evenes ae wien fo his penaly scheme as, R e [ pf 1 ]. 32 Analogos o he ealie case, we fis deive he oal deivaive of expeced evenes 32 wih espec o he exempion level, oyaly ae, and acal havesing, aking he elaionship beween acal and epoing havesing ino accon. Then, we solve fo d e, which depends on dr 0 finding he expession fo he oal deivaive of acal havesing, Finally, we sbsie fom he fome ino he lae and obain, d d d. d d e dr 1 [ pf 1 pf ] 0 33 In he denominao, 0, 0, and - pf > 0. We assme ha he denominao is posiive fom heeon. Fo he nmeao, we can follow pocedes simila o he deivaion of and obain, 1 {[1 p U Y pu ] 0 34 This implies, d d e dr

23 22 We now finally have, Poposiion 5. Unde a penaly scheme whee he fine is assessed agains ndeclaed havesing, highe oyaly pogession, which holds expeced oyaly collecion evenes consan, will decease acal havesing. The inepeaion of Poposiion 5 is simila o Poposiion 4. Boh show ha he effec of axevene neal oyaly pogession is o edce acal havesing nde boh penaly schemes, nlike in he case of epoed havesing. In Appendix 4 we show ha a egessive ax-evene neal efom, ha inceases he lmp sm fee and compensaes i by deceasing he oyaly ae, will incease acal havesing. Ths, he desiabiliy of he sggesed combinaion of a lmpsm fee and a oyaly ae vey mch depends on whehe nepoed havesing is he only fom of illegal logging o no. If i is, hen a egessive ax sysem pefoms bes, becase i edces nepoed havesing and inensifies he se of he concession. If he havese has an incenive o haves moe han he concession igh allows, hen a egessive sysem is less desiable. 5. Conclsions In his pape we sdy oyaly efom in economies wih foes concessions. This has become an impoan isse in he foesy lieae, as i has been aged ha oyalies applied o concessions havesing ae oo low, and ha hey do no allow enogh en cape by he govenmen, hs ceaing incenives fo defoesaion. We develop a ax evasion model o examine he sggesed efom owads a combinaion of a foes fee o sbsidy applied o a concession igh and a highe oyaly ae on havesing. This model allows s o ask how pogession o egession of his combinaion can be sed o decease illegal havesing aciviies in he impoan case whee expeced govenmen evenes emain a consan levels. O analysis is he fis o examine oyaly efom in a conex of illegal logging-elaed aciviies, when cheaing migh no be pefecly deeced by he govenmen.

24 23 A ciical pa of o analysis is o ndesand he incenive fo haveses o engage in illegal ndeepoing of haves volmes, which is a common poblem hogho he wold in developing economies wih concessions. We examine how oyaly efom affecs epoed havesing and acal havesing of a concession nde wo diffeen penaly schemes, whee he cheaing havese when deeced ms pay eihe a fine based on he evaded oyaly paymen, o one based on ndeclaed havesing. We model he linkages beween concession havesing, cheaing and deecion in hee sages. Acal haves volme is decided pon by he havese in he fis sage. In he second sage, he havese chooses wha facion of acal havesing is epoed o he govenmen fo oyaly paymen. Finally, he havese s nceainy egading deecion o non-deecion of cheaing by he govenmen is evealed. We show ha while highe oyaly ax pogession seves o decease acal havesing independen of he penaly scheme, is effec on epoed havesing is sensiive o he penaly scheme. In paicla, nde a penaly scheme whee he fine is levied on evaded oyaly paymens, an incease in oyaly pogession ha holds expeced govenmen evenes consan will incease epoed havesing and decease cheaing by concession haveses. Howeve, when he penaly scheme has he fine levied on ndeclaed havesing, he evese happens; a ise in evene-neal oyaly pogession will decease epoed havesing. In his case, moe appopiae efom is a egessive oyaly sysem, becase highe egession will incease epoed havesing. These esls add o he cen policy debae sonding oyalies and help s assess he ofen-sggesed efom of oyaly sysems owads a combinaion of a minimm lmp-sm fee and a oyaly ae. Obviosly, his sggesion has some mei, b we have demonsaed ha his combinaion shold be pogessive o egessive depending on he penaly scheme implemened wih he oyaly sysem, and depending on he possible nde- o ove-se of he concession ighs by he havese. Illegal logging, i.e. havesing moe han he concession igh pemis,

25 24 can be edced by a pogessive oyaly sysem. Unde-se of he concession igh can be coeced by a egessive ax sysem. Ths, hee is consideable scope o aylo oyaly sysems o he paiclas of each cony and he chaaceisics of illegal logging in he cony. In o pape we have focsed oyaly efom analysis by keeping expeced oyaly collecion fixed, and we have assmed an exogenos pobabiliy of deecion and penaly by he govenmen. The fis assmpion is impoan becase i povides incenive fo poo developing cony govenmens o efom oyalies. In fe wok, i wold be ineesing o ea enfocemen as a poenial policy insmen. In ha case, one cold ask how he govenmen shold joinly design oyalies and enfocemen schemes o boh cape ens fom concession havesing, conol illegal logging-elaed aciviies, and limi defoesaion.

26 25 Appendix 1: Second-ode condiions of epoed and acal havesing Repoed havesing A. Fine levied on evaded oyaly paymens The second ode condiion fo he choice of epoed havesing is, 2 1 p U Y p f 1 U 0. Using eqaion 9 and he definiion of absole isk avesion, A. U ''. U '. o ewie he maginal iliies, we can show ha he second ode condiion fo a maximm holds, 1 p U Y [ A Y f 1 A ] 0 A.1 B. Fine levied on ndeclaed havesing The second ode condiion is [1 p U Y 2 p f 2 U ] 0. Using and making se of he definiion of absole isk avesion we have, p 1 p U Y f U 1 p U Y [ A Y f A ] 0. A.2 Acal havesing A. Fine levied on evaded oyaly paymens The second ode condiion becomes, 2 1 p U Y aˆ pu bˆ 2 [1 p U Y pu ] C. Fom he fisode condiion ˆ 1 p U' Y aˆ pb and sing absole isk avesion as befoe, we have U' ˆ 1 p U Y aˆ[ A b A Y aˆ] [1 p U Y pu ] C 0 A.3 B. Fine levied on ndeclaed havesing Using he ineio solion we have, ~ 1 p U Y a pb ~ and he definiion of absole isk avesion U ~ ~ ~ 1 p U Y a[ A b A Y a] [1 p U Y pu ] C 0 A.4

27 26 Appendix 2. Compaaive saics of epoed havesing A. Fine levied on evaded oyaly paymens Obaining he paial deivaive of 7 wih espec o he exogenos in he second sage, sing 9, and making se of he definiion of absole isk avesion, we have, U Y U 1 p U Y [ a b] 1 p U Y [ A b A Y a] 0,A.5 U Y U whee a and b ae defined in he ex. Using A.1, he effec of a change in acal havesing on epoed havesing can be expessed as, A Y a A b, A.6 [ A Y f 1 A ] Unde DARA highe acal havesing inceases epoed havesing and he same happens nde 1 CARA, when 0. Fo he ax exempion we have he following coss paial deivaive sing 7, 1 p U Y p f 1 U A.7 Using he definiion of absole isk avesion and eqaion 9 o ewie eqaion A.7, we have [ A Y A ] A.8 [ A Y f 1 A ] The sign of eqaion A.8 depends on isk avesion behavio. Unde CARA 0, b nde DARA, 0, so ha a highe exempion will decease epoed havesing. Finally, fo he oyaly ae we have fom 7, 1 p U Y p f 1 U [ 1 f ] A.9 Ths, he effec of he oyaly ae is given by, A Y A 1 f, A.10 [ A Y f 1 A ] whee again we have made se of 9 and absole isk avesion. The nmeao of A.10 is posiive when A. 0 and 1. Ths nde DARA, a ise in he oyaly ae inceases 1 epoed havesing, while nde CARA i simplifies o 0. B. Fine levied on ndeclaed havesing Fo he impac of acal havesing we have he following coss paial deivaive,

28 27 ] 1 [ ] [ 1 f C q U f p C q Y U p, A.11 whee, a and b ae defined in he ex. Eqaion A.11 can be ewien, sing absole isk avesion and he fis-ode condiion 11 as ] [ 1 a A Y b A Y U p A.12 Ths he effec of acal havesing is given by, 0 ] [ A f A Y b A a A Y A.13 Unde DARA, 0, and nde CARA, f f f b a A.14 Nex we conside a effec of he oyaly exempion level. We obain, ] [ 1 2 Y A A Y U p A.15 Ths we have, ] [ ] [ f A A Y A A Y E. A.16 Unde DARA, he sign A.16 is negaive, while i eqals zeo nde CARA. Finally, fo we se again 1 U Y U p f p o obain ] [ ] [1 Y A A U f p pu Y U p A.17 Ths we have, ] [ 1 ] [ ] [1 A f A Y Y U p A Y A U f p pu Y U p A.18 The fis backeed em in he nmeao epesens he sbsiion effec ha follows fom he oyaly insmen. Given he penaly scheme, he oyaly cases a disoion o he havese s choice of epoed havesing. is ambigos nde DARA, and negaive nde CARA. Appendix 3. Compaaive saics of acal havesing A. Fine levied on evaded oyaly paymens Fis conside he coss paial deivaive of wih espec o boh and,

29 28 [1 p U Y aˆ pu bˆ] A.19 Making se of 15 and he absole isk avesion mease, we can ewie A.19 as, 1 p U Y aˆ[ A A Y] A.20 The effec of he oyaly exempion on acal havesing is given by, 1 p U Y aˆ[ A A Y ] A.21 1 p U Y aˆ[ A bˆ A Y aˆ] [1 p U Y pu ] C Ths, acal havesing inceases as he exempion level is aised nde DARA, b nde CARA 0. Nex we examine how acal havesing esponds o he oyaly ae, [1 p U Y pu 1 ] 1 p U Y aˆ pu bˆ f 1 Making se of 15 again, can be wien, [1 p U Y pu 1 ] A.22 1 p U Y aˆ[ A 1 x A Y] f 1 whee x 0. Ths, 0, so ha 0 fo A'. 0. B. Fine levied on ndeclaed havesing Fo he ax exempion, we need o compe ~ he following coss paial deivaive, [1 ~ p U Y a pu b ] A.23 Using 32 gives, ~ 1 p U Y a[ A A Y ], A.24 which is posiive nde DARA and zeo nde CARA. This implies ha he impac of an incease in he exempion level on acal havesing depends on absole isk avesion, 0 if A. 0 and 0 if A. 0 A.25 Compaing A.25 wih A.21 we see ha he penaly scheme does no mae in ems of he effec of exempion levels on acal havesing. The impac of he oyaly ae can be deived sing pocedes simila o A.23 - A.25 and is given by, 0 if A. 0 and 0 if A. 0 A.26 Appendix 4. Regessiviy and he fine on ndeclaed havesing A. Repoed havesing The objecive fncion of he havese is, Max 1 p U Y pu, A.27

30 29 whee Y q c, Y f 1, is he oyaly ax ae and is he lmp-sm foes fee. The fis-ode condiions ae 0 1 p U' Y p f U' 0, and he ineio solion implies pf 0. The second-ode condiion is A Y f A 0 1 p U' Y. Fo he lmp sm fee and he oyaly ax ae we have 1 p U' Y A A Y 0 if A' 0 A.28 1 p U' Y pu' p f U' A A Y? 0 if A' 0 A.29 The govenmen s expeced ax evene is, pf 1 e R A.30 The changes in axes and epoed havesing, which will keep A.30 consan, ae given by, e dr 0 d d pf d, so ha d e d pf d dr 0 fo d in he eqaion d d. Sbsiing he RHS of above eqaion d gives, d d e 1 dr pf 0, A.31 whee he denominao is posiive becase 0 and pf 0 a he ineio solion. In ems of he nmeao we have, d d e dr pf 1 p U' Y pu' 0 0., so ha A.32 The ax scheme is egessive becase he aveage ax ae deceases wih he R epoed ax base, i.e. R so ha. The highe is he lmp-sm fee, he moe egessive is he ax scheme. Ths, a highe lmp-sm

31 30 fee level compensaed by a lowe oyaly ae will incease he epoed havesing. B. Acal havesing The fis-ode condiion fo acal havesing de o he envelope heoem can be wien as ~ ~ 0 1 p U ' Y a pu ' b 0, A.33 whee ~ ' ~ a q c 0 and b q c' f 1 0. The second-ode condiion is 0. The coss-deivaives of he fis-ode condiion wih espec o fo he lmp-sm fee and fo he oyaly ae, especively, ae A Y A 0 as A' 0 1 p U' Y a ~ A.34a 1 p U ' Y pu ' 0 as A ' 0 A.34b Hence, 0 as A' 0 and 0 as A' 0 The govenmen s expeced ax evene is, R e pf 1 A.35 The changes in axes and acal havesing, which will keep A.35 consan ae d e d pf 1 pf dr d. 0 Sbsiing he RHS of above eqaion fo d in d d e dr 0 1 pf 1 d pf d d gives,, A.36 whee he denominao is assmed o be posiive nde A ' 0. In ems he nmeao, A.34a and A.34b indicae ha 1 1 p U ' Y pu ', so ha d d dr e A.38 Hence a highe lmp-sm fee level compensaed by a lowe oyaly ae will incease he acal havesing, as discssed afe Poposiion 5.

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