Endogenous Tax Evasion and Reserve Requirements: A Comparative Study in the Context of European Economies

Given that data indicates several countries with same, or nearly same, degree of tax evasion but widely different levels of reserve requirements, this paper analyzes the relationship between the ``optimal" degree of tax evasion and mandatory cash reserve requirements required to be held by banks using a simple overlapping generations framework. Proceeding on the initial premises that the above observation may be a fallout of the possibilities of multiple levels of tax evasion given the reserve requirements and other policy variables, or that the optimal degree of tax evasion may be completely unaffected by the movements in reserve requirements, we find the latter to be true. The model also suggests the following: (i) An economy with a less corrupt structure will have a higher steady-state of value of reported income; (ii) Increases in the penalty rates of evading taxes would induce consumers to report greater fraction of their income, while increases in the income-tax rates would cause them to evade greater fraction of their income, and ; (iii) The model does not vindicate the popular belief in the literature that, countries with lower percentage of reported income tend to have higher reserve requirements