Scandinavian Working Papers in Economics

Working Paper Series,
IFAU - Institute for Evaluation of Labour Market and Education Policy

No 2004:4: Does tax evasion affect unemployment and educational choice?

Ann-Sofie Kolm and Birthe Larsen
Additional contact information
Ann-Sofie Kolm: IFAU - Institute for Labour Market Policy Evaluation, Postal: Box 513, SE-751 20 Uppsala, Sweden
Birthe Larsen: Copenhagen Business School, Postal: Solbjerg Plade 3, DK-2000 Copenhagen, Denmark

Abstract: To examine the macro economic effects of government tax and punishment policies, this paper develops a three-sector general quilibrium model featuring matching frictions, heterogenous abilities and an informal sector with tax evasion. The choice of education is determined endogenously. Job opportunities in an informal sector are available only to workers who choose not to acquire higher education. We find that increased punishment of informal activities increases the number of educated workers and reduces the number of unemployed workers. Characterizing the optimal tax and punishment system, we show that it is optimal to more than fully counteract the distortion created by the government’s inability to tax the informal sector. The optimal choice of tax and punishment system, however, implies an inefficiently low stock of educated workers.

Keywords: Tax evasion; underground economy; education; matching; unemployment

JEL-codes: H26; I21; J64

37 pages, April 15, 2004

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