Scandinavian Working Papers in Economics

Research Papers in Economics,
Stockholm University, Department of Economics

No 1999:19: Tax Evasion: A Real Option Approach

Tomas Forsfält
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Tomas Forsfält: Dept. of Economics, Stockholm University, Postal: Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden

Abstract: A theoretical model of excise tax evasion is developed in this paper. The dynamics of a change in tax policy is derived, under the assumption that consumers benefit from a lower price when entering a "black market". However, entry also impose a sunk cost, which gives rise to asymmetric effects and persistence effects on both aggregate demand and on tax revenues. An increase in the tax rate instantaneously brings more entrants into the black market, whereas a tax cut has no short-run effects on the fraction of the population that has access to the black market.

Keywords: excise tax; real option; social norm; tax evasion

JEL-codes: H26

26 pages, November 1, 1999

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