Tax Evasion in a Dynamic General Equilibrium Model
32 Pages Posted: 7 Apr 2020
Date Written: March 16, 2020
We model tax evasion in the context of an endogenous growth model with two actors: a private agent and the government. The private agent invests his/her endowment of physical capital in the production of a private good. The income derived is used for consumption activities and to finance a public good that improves the productivity of private investments. However, due to fiscal illusion, the private agent may decide to under-report income for tax purposes. The government is benevolent, wants to maximize long run growth and uses a public agency to collect tax revenues and to audit consumers. Tax administration chooses audit frequency and fines in order to maximise the expected tax revenue, given the institutional parameters. In this setting, we study the long term properties of tax evasion; in particular 1) how tax evasion affects the equilibrium outcomes for the economy; 2) what are the important conditions that lead to self-perpetuating tax evasion. We show that the cost incurred by private agents to evade and audit efficiency have a fundamental role in determining these relationship. When private costs are sufficiently high an increase in the tax rate leads to a decrease in the tax revenue. On the other hand, when these expenditure are sufficiently low tax evasion may be reduced by increasing the tax rate. In both cases, public expenditure will be suboptimal in equilibrium.
Keywords: dynamic tax evasion, general equilibrium, growth, corruption, optimal tax and audit policy
JEL Classification: G11, H26, H42
Suggested Citation: Suggested Citation