Tax evasion, enforcement and intertemporal choice

Abstract

Tax evasion is a widespread phenomenon in all economies, and assumes great significance in developing countries. Theoretical analyses of tax evasion, however, have concentrated on simplistic models which are static and have fixed audit probabilities. This overlooks two important issues: that all evaders are not audited with the same frequency, and the interaction between evasion and saving decisions. The dissertation investigates these issues. Its first paper looks at enforcing compliance and truth-telling in a simple principal-agent framework. The second paper examines the broader issue of saving and portfolio decisions with an endogenous return to the risky asset. The focus in the final paper is the intertemporal behavior of the evader in a dynamic overlapping-generations setting. The investigation finds that endogenous audit probability plays a major role in affecting evasion behavior. Firstly, the degree of enforcement activity by the tax authority is now found to depend on the degree of the progressivity of the tax structure. In the second paper, the behavior of consumption and speculation (holding risky assets) when the endogenous risk increases is found to be determined by three effects: in addition to the standard income and substitution effects, there is a third endogeneity effect which tends to increase saving and speculation over the levels that are determined in simpler models. In the final paper, it is shown that the savings behavior evaders, even when they are risk-neutral, would depend on the degree of evasion in the economy as a whole. Northern evaders (in a low-evasion economy) would increase saving when tax rates fall, but the savings of evaders in the high-evasion South would be lowered as they adjust for possibly lower penalties from lower evasion. Lowering tax rates during a tax reform may therefore decrease a Southern economy\u27s stock of savings and capital for long-term growth. The issues raised by a more detailed analysis of tax evasion are therefore significant, and can make significant differences to deciding on appropriate policy mixes for authorities in high-evasion economies