POVERTY, TAX EVASION AND THE OPTIMUM GENERAL INCOME TAX

Abstract

This paper combines poverty considerations in the social welfare function and tax evasion into an optimal general income tax problem. It investigates the optimal audit and tax structures using a model with two types of individual, endogenous labor supply and a hybrid social welfare function that captures the pluralism of the objectives of a full committed government. The results confirm the previous literature on tax evasion: (i) skilled households should never be audited and face any distortions in the labor supply, (ii) unskilled households have to be audited randomly (probability less than one) and (iii) Individuals should be rewarded if telling the truth about their income. In addition, the introduction of poverty concern as a negative externality brings new characteristics for the optimum income tax on poor: (iv) they may (or not) face negative marginal income tax. Also, a numerical example is provided to further explore the model.