Black Markets and Optimal Evadable Taxation

John McLaren

Economic Journal, 1998, vol. 108, issue 448, 665-79

Abstract: In a simple model of evadable indirect taxation, some surprises emerge. Because of a 'market-thinning' effect of high prices, high taxes induce multiple equilibria (low-price black markets and high-price legal markets). Further, evadability introduces a bifurcation to optimal taxation: for less effective tax administrations, the optimal tax system follows a 'cash cow' pattern, with one sector bearing all of the tax; but for relatively effective administrations, the optimum follows a slightly modified Ramsey rule. This discontinuity results from the mathematics of evasion incentives and may help explain tax reforms commonly seen over the course of economic development.

Date: 1998
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Persistent link: https://EconPapers.repec.org/RePEc:ecj:econjl:v:108:y:1998:i:448:p:665-79

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