Increasing returns-to-Scale Evasion Technologies and Optimal Commodity Taxation

This paper examines the implications of increasing returns-to-scale evasion technologies for the optimal structure of commodity taxes. We find that, in the presence of evasion, tax design should aim at inducing uniform marginal evasion responses across commodities. This objective may dominate the concerns over inter-commodity distortions stressed by the traditional optimal commodity taxation literature. The resulting optimal tax structure can thus be more, or less, uniform than the one prescribed in the absence of evasion, even when uniform commodity tax is feasible. In particular, our results imply that the presence of evasion may yield an optimal tax structure which features relatively low tax rates on commodities that have relatively low price elasticities of demand, if the demand for those commodities is relatively large. On the other hand, when all transactions are of similar size, the presence of evasion may provide a rationale for broad-based uniform taxation.