Dynamic Tax Evasion and Capital Misallocation in General Equilibrium

Francesco Menoncin, Andrea Modena and Luca Regis

Carlo Alberto Notebooks from Collegio Carlo Alberto

Abstract: We study tax evasion in a tractable macroeconomic model with productive public expenditure financed by a fixed-rate income tax. Taxpayers are heterogeneous in their productivity and subject to borrowing constraints. They can lower their fiscal burden by evading taxes at the risk of being audited (and fined) by the government. We solve the model for its competitive equilibrium and characterize entrepreneurs’ optimal policies contingent on their individual productivity and the endogenous price levels. The model predicts that enforcing tax compliance stimulates the productivity of public expenditure, thus making less productive enterprises viable. At the same time, however, fewer evasion opportunities alleviate borrowing constraints by offsetting the advantage of low-productivity (and highly-evasive) entrepreneurs, thereby re-allocating capital to more productive users. On the demand side, decreasing tax evasion reduces consumption levels by curbing private capital accumulation. However, it fosters consumption rates by mitigating entrepreneurs’ precautionary motif against auditing risk.

Keywords: Dynamic Tax Evasion; Financial Frictions; General Equilibrium; Misallocation (search for similar items in EconPapers)
Pages: 46 pages
Date: 2022
New Economics Papers: this item is included in nep-acc, nep-dge, nep-fdg, nep-iue, nep-pbe and nep-pub
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Persistent link: https://EconPapers.repec.org/RePEc:cca:wpaper:679

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