Taxation, Compliance, and Clandestine Activities

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

No 25-06, Working Paper from Federal Reserve Bank of Richmond

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 hours between legal and clandestine (illicit) activities. These distortions lower the constrained optimal tax rate and result in the under-provision of the public good. This under-provision problem is mitigated when surplus from the audit agency is seamlessly transferred to the taxing authorities. Extensions of the basic model incorporate agent heterogeneity and a more general specification of the concealment cost function for infringements.

Keywords: Taxation; evasion; compliance; legal and illicit activities; public goods; externalities (search for similar items in EconPapers)
JEL-codes: H40 K10 (search for similar items in EconPapers)
Pages: 93
Date: 2025-09
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Working Paper: Taxation, Compliance, and Clandestine Activities (2025)
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DOI: 10.21144/wp25-06

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