Tax Evasion, Conspicuous Consumption, and the Income Tax Rate

Very often tax collectors initiate an audit on the basis of observed spending capacity that does not seem to conform with declared income. This requires the skillful evader to carefully consider his or her expenditures on conspicuous consumption to avoid drawing the attention of the tax collector. The present article develops a simple model of the taxpayer’s joint evasion-consumption decision that is used to reexamine the widely discussed relationship between tax evasion and the income tax rate. Contrary to the literature’s counterintuitive result, the article shows that an increase in the income tax rate will unambiguously increase the taxpayer’s level of evasion. Furthermore, given that taxpayers vary in their level of true income, a tax rate increase will increase the number of tax evaders as well, consequently increasing the total amount of taxes escaping the tax collector. A related model of boasting about tax evasion is shown to yield some similar results.