Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 721: Tax Evasion Dynamics

Dirk Niepelt ()
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Dirk Niepelt: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 69 Stockholm, Sweden

Abstract: I study the dynamic tax evasion program of a household with many sources of income. Contrary to the previous literature, I assume that the detection risk of tax evasion is uncorrelated across these sources. If detection triggers the repayment of currently and previously evaded taxes, the marginal cost of evasion increases over time and the optimal duration of evasion is positive but finite. With stochastic pre-tax income, the fraction of aggregate taxes evaded remains interior, even if detection triggers duration-independent penalties. The model helps to understand the recent European debate about the cross-border exchange of information about capital income as opposed to taxation at the source. It yields a transparent representation of the revenue and efficiency losses due to tax evasion and highlights various effects of tax policy on evasion.

Keywords: Tax evasion; hysteresis; inaction range; optimal taxation; information exchange

JEL-codes: E60; H20

29 pages, July 8, 2003

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