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Trading Off Tax Distortion and Tax Evasion

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  • WOLFRAM F. RICHTER
  • ROBIN W. BOADWAY

Abstract

Income tax evasion is modeled as a risky activity and integrated into a standard optimal tax problem in which there is a good whose sales are observable. If the penalty for evasion is proportional to the tax evaded (the Yitzhaki scheme), the optimal tax structure is unaffected by evasion. If the penalty is proportional to unreported income (the Allingham–Sandmo scheme), it is efficient to tax both the observable good and income. The cost of the risk of tax evasion is traded off against the distortion from taxing the observable good. For equal penalties, Allingham/Sandmo is more efficient than Yitzhaki.

Suggested Citation

  • Wolfram F. Richter & Robin W. Boadway, 2005. "Trading Off Tax Distortion and Tax Evasion," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 7(3), pages 361-381, August.
    • Handle: RePEc:bla:jpbect:v:7:y:2005:i:3:p:361-381
    DOI: 10.1111/j.1467-9779.2005.00208.x
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