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The Relative Tax Gap Hypothesis: An Exploratory Analysis and Application to U.S. Financial Markets

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  • Cebula, Richard J.

    (George Mason University)

Abstract

This study empirically investigates the “relative tax gap hypothesis,” which posits that the greater the size of the relative tax gap, the greater the degree to which the U.S. Treasury must borrow from domestic and/or other credit markets and hence the higher the ex ante real interest rate yield on the Bellwether 30 year U.S. Treasury bond. The study uses the most current data available for computing what is referred to here as the “relative tax gap,” which is the ratio of the aggregate tax gap (the loss in federal income tax revenue resulting from personal income tax evasion) to the GDP level. For each year of the study period, the nominal value of the tax gap is scaled by the nominal GDP level and expressed as a percentage. The study period runs from 1982 through 2016, reflecting data availability for all of the variables. The estimation results provide strong support for the hypothesis. In addition, in separate estimations, evidence is provided that the relative tax gap also acts to elevate the ex ante real interest rate yield on Moody’s Baa-rated long-term corporate bonds. It logically follows, then, that to the extent that a greater relative tax gap leads to higher ex ante real interest rates, it may contribute to the crowding out of corporate investment in new plant equipment associated heretofore with government budget deficits per se.

Suggested Citation

  • Cebula, Richard J., 2020. "The Relative Tax Gap Hypothesis: An Exploratory Analysis and Application to U.S. Financial Markets," American Business Review, Pompea College of Business, University of New Haven, vol. 23(1), pages 35-52, May.
    • Handle: RePEc:ris:ambsrv:0003
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    More about this item

    Keywords

    Aggregate personal income tax evasion; Relative tax gap; ex ante Real interest rate yield on the Bellwether bond; Moody’s Baa-rated long-term corporate bonds; Reduced investment in new plant and equipment;
    All these keywords.

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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