Public Good Provision, Tax Evasion, and Illicit Production

Subhayu Bandyopadhyay, Sugata Marjit, Santiago Pinto () and Marcel Thum

No 2025-005, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We investigate the trade-off policymakers face between raising tax revenues for public good provision and mitigating the distortionary effects of taxation when individuals can evade taxes and allocate work time between legal and illicit activities. These distortions lower the constrained optimal tax rate and lead to the under-provision of the public good. This under-provision problem is mitigated when surplus generated by the audit agency is seamlessly transferred to the taxing authorities. Extensions of the basic model allow the government to endogenously choose the audit intensity as part of the tax enforcement policy, introduce agent heterogeneity, and consider a more general concealment cost function.

Keywords: taxation; evasion; compliance; illicit activities; public goods; externalities (search for similar items in EconPapers)
JEL-codes: H2 H4 K10 (search for similar items in EconPapers)
Pages: 91 pages
Date: 2025-03-19, Revised 2026-06-14
New Economics Papers: this item is included in nep-acc, nep-iue, nep-pbe and nep-pub
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DOI: 10.20955/wp.2025.005

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