Combining Optimal Tax Evasion with the Policy Objectives of Equity/Efficiency

Abstract

The equity/efficiency tradeoff is a fairly extensive topic in economic literature. A large body of work has concentrated efforts on a variety of relevant issues, such as the determining factors of equity and efficiency and the potentially damaging economic consequences in terms of government failure in choosing the proper mix of fiscal objectives. However, no attempt has been made so far to use adjustments in tax rates in order to define an optimal equity/efficiency level that could be combined with the government's aim of playing a more prominent role in promoting the optimal fiscal policy objectives. in the present study, we find that changes in direct/indirect tax rates are capable of affecting not only the optimal level of evasion but also the optimal policy goals of equity/efficiency. To this end, a theoretical optimization model is constructed, the first-order conditions are properly manipulated and simulations are conducted to determine optimal evasionand optimal allocation of resources to the fiscal objectives of equity and/or efficiency. the model is empirically tested by employing data from 35 countries over the period 2007–2015.

Keywords

direct-indirect tax rates equity-efficiency objectives tax evasion voting process income redistribution incentives

Get full access to this article

View all access options for this article.

References

Aaberge

and Colombino

(2012) “Accounting for family background when designing optimal income taxes: a micro econometric simulation analysis”, Journal of Population Economics, 25(2):741–761.

Allingham

M.G.

and Sandmo

(1972) “Income tax evasion: A theoretical analysis”, Journal of Public Economics, 1(3–4):323–338.

Alm

(1985) “The welfare cost of the underground economy”, Economic Inquiry, 23(2):243–263.

Andersen

(1977) “Tax evasion and labour supply”, Scandinavian Journal of Economics, 79(3):375–383.

Anderson

, Palma

, and Kreider

(2001) “The efficiency of indirect taxes under imperfect Competition”, Journal of Public Economics, 81(2):231–251.

Andreoni

, Erard

and Feinstein

(1998) “Tax Compliance”, Journal of Economic Literature, 36(2):818–860.

Aronson

, Lambert

, and Trippeer

(1999) “Estimates of the changing equity characteristics of the U.S. income tax with international conjectures”, Public Finance Review, 27(2):138–159.

Auerbach

and Hassett

(2002) “A New Measure of Horizontal Equity”, American Economic Review, 92(4):1116–1125.

Auerbach

and Hines

(2002) “Taxation and economic efficiency”, in: Handbook of Public Economics“, 3, Edited by Auerbach

A.J

and Feldstein

10.

Avi-Yonah

R.S.

(2002) “Why Tax the Rich - Efficiency, Equality, and Progressive Taxation”, The Yale Law Journal, 111(6):1391–1416.

11.

Baldry

J.C.

(1987) “Income tax evasion and the tax schedule: Some experimental results”, Public Finance, 42(3):357–383.

12.

Benjamini

and Maital

(1985) “Optimal tax evasion and optimal tax evasion policy: Behavioural aspects”, in: Gaertner

and Wenig

(eds) The Economics of the Shadow Economy, Studies in Contemporary Economics, Springer, Berlin, Heidelberg, pp. 245–264.

13.

Berliant

and Strauss

(1993) “State and Federal Tax Equity-Estimates Before and After the Tax Reform Act of 1986”, Journal of Policy Analysis and Management, 12(1):9–43.

14.

Bierbrauer

(2009) “Optimal income taxation and public good provision with endogenous interest groups”, Journal of Public Economic Theory, 11(2):311–342.

15.

Blackorby

and Brett

(2004) “Production efficiency and the direct-indirect tax mix”, Journal of Public Economic Theory, 6(1):165–180.

16.

Boadway

and Pestieau

(2002) “Indirect Taxation and Redistribution: The Scope of the Atkinson-Stiglitz Theorem”, Queen's Economics Department Working Paper, No. 1005, Queen's University, Department of Economics, Kingston (Ontario).

17.

Bordignon

(1993) “Fairness approach to income tax evasion”, Journal of Public Economics, 52(3):345–362.

18.

Brendon

(2013) “Efficiency, Equity, and Optimal Income Taxation”, European University Institute, Max Weber Programme, EUI Working Paper MWP 2013/22.

19.

Bucovetsky

and Smart

(2006) “The efficiency consequences of local revenue equalization: Tax competition and tax distortions”, Journal of Public Economic Theory, 8(1):119–144.

20.

Chateauneuf

(1994) “Modeling attitudes towards uncertainty and risk through the use of Choquet integral”, Annals of Operations Research, 52(1):1–20.

21.

Christiansen

(1980) “Two comments on tax evasion”, Journal of Public Economics, 13(3):389–393.

22.

Clotfelter

C.T.

(1983) “Tax evasion and tax rates: An analysis of individual returns”, Review of Economics and Statistics, 65(3):363–373.

23.

Cowell

(1985) “Tax evasion with labour income”, Journal of Public Economics, 26(1):19–34.

24.

Crane

S.E.

and Nourzad

(1986) “Inflation and tax evasion: An empirical analysis”, Review of Economics and Statistics, 68(2):217–223.

25.

Crawford

(1997) “The Utility of the Efficiency/Equity Dichotomy in Tax Policy Analysis”, Virginia Tax Review, 16(1):502–534.

26.

Cremer

, Marchand

and Pestieau

(1990) “Evading, auditing and taxing: The equity-compliance tradeoff”, Journal of Public Economics, 43(1):67–92.

27.

Cross

, and Shaw

G.K.

(1982) “On the economics of tax aversion”, Public Finance, 37(1):36–47.

28.

Cuccia

, and Carnes

(2001) “A closer look at the relation between tax complexity and tax equity perceptions”, Journal of Economic Psychology, 22(2):113–140.

29.

Decoster

, Loughrey

, O' Donoghue

and Verwerft

(2010) “How Regressive Are Indirect Taxes? A Microsimulation Analysis for Five European Countries”, Journal of Policy Analysis and Management, 29(2):326–350.

30.

Diamond

and Saez

(2011) “The Case for a Progressive Tax: From Basic Research to Policy Recommendations”, Journal of Economic Perspectives, 25(4):165–190.

31.

Dixon

and Rimmer

(1999) “Changes in Indirect Taxes in Australia: A Dynamic General Equilibrium Analysis”, The Australian Economic Review, 32(4):327–348.

32.

Elkins

(2006) “Horizontal Equity as a Principle of Tax Theory”, Yale Law & Policy Review, 24(1):43–90.

33.

Emran

M.S.

and Stiglitz

(2005) “On selective indirect tax reform in developing countries”, Journal of Public Economics, 89(4):599–623.

34.

Fuest

, Peichl

, and Schaefer

(2008) “Does a Simpler Income Tax Yield More Equity and Efficiency?”, CESifo Economic Studies, 54(1):73–97.

35.

Genser

and Haufler

(1996) “Tax competition, tax coordination and tax harmonization: The effects of EMU”, Empirica, 23(1):59–89.

36.

Gooroochurn

, and Milner

(2005) “Assessing Indirect Tax Reform in a Tourism-Dependent Developing Country”, World Development, 33(7):1183–1200.

37.

Gordon

(1987) “Modelling tax evasion where honesty may be the best policy”, Discussion paper no. 102, Jan., Economic and Social Research Council Programme: Taxation, Incentives, and the Distribution of Income (London School of Economics).

38.

Gouveia

and Strauss

(1994) “Effective federal individual income tax functions: An exploratory empirical analysis”, National Tax Journal, 47(2): 317–39.

39.

Hashimzade

, Myles

and Tran-Nam

(2013) “Applications of behavioural economics of tax evasion”, Journal of Economic Surveys, 27(5):941–977.

40.

Hungerbühler

, Lehmann

, Parmentier

and Van Der Linden

(2008) “A Simple Theory of Optimal Redistributive Taxation with Equilibrium Unemployment”, Economie publique/Public economics, Institut d'économie publique (IDEP), pp. 203–218.

41.

Hyun

J-K.

and Lim

B.-I.

(2005) “Redistributive effect of Korea's income tax: equity decomposition”, Applied Economics Letters, 12(3):195–198.

42.

Infanti

(2008) “Tax Equity”, Buffalo Law Review, 55(4):1191–1260.

43.

Isachsen

A. J.

and Strom

(1980) “The hidden economy: The labour market and tax evasion”, Scandinavian Journal of Economics, 82(2):304–311.

44.

Jacobs

, de Mooij

, and Folmer

(2010) “Flat income taxation, redistribution and labour market performance”, Applied Economics, 42(25):3209–3220.

45.

Kaplanoglou

and Newbery

(2003) “Indirect Taxation in Greece: Evaluation and Possible Reform”, International Tax and Public Finance, 10(5):511–533.

46.

Kaplanoglou

and Newbery

(2004) “Redistributive Impact of Indirect Tax Reforms: Greece, 1988–2002”, Fiscal Studies, 25(2):225–247.

47.

Kaplow

(1995) “A fundamental objection to tax equity norms: A call for utilitarianism”, National Tax Journal, 48(4):497–514.

48.

Karakosta

, Kotsogiannis

, and Lopez-Garcia

M. A.

(2014) “Indirect tax harmonization and global public goods”, International Tax Public Finance, 21(1):29–49.

49.

Keen

and Lockwood

(2010) “The value added tax: Its causes and consequences”, Journal of Development Economics, 92(2):138–151.

50.

King

and Sheffrin

(2002) “Tax Evasion and Equity Theory: An Investigative Approach”, International Tax and Public Finance, 9(4):505–521.

51.

Kleven

H. J.

, Kreiner

C. T

and Saez

(2009) “Notes and comments the optimal income taxation of couples”, Econometrica, 77(2):537–560.

52.

Kolm

S. C.

(1973) “A note on optimum tax evasion”, Journal of Public Economics, 1973, 2(3):265–270.

53.

Lambert

and Yitzhaki

(1995) “Equity, equality and welfare”, European Economic Review, 39(3–4):674–682.

54.

Landsberger

and Meilijson

(1982) “Incentive generating state dependent penalty system”, Journal of Public Economics, 19(3):333–352.

55.

Lewis

(1979) “An empirical assessment of tax mentality”, Public Finance, 34(2):245–257.

56.

Listokin

(2012) “Equity, Efficiency, and Stability: The Importance of Macroeconomics for Evaluating Income Tax Policy”, Yale Journal on Regulation, 29(1):45–89.

57.

Makdissi

and Mussard

(2008) “Analyzing the impact of indirect tax reforms on rank-dependent social welfare functions: a positional dominance approach”, Soc Choice Welfare, 30:385–399.

58.

Mason

and Calvin

L. D.

(1984) “Public confidence and admitted tax evasion”, National Tax Journal, 37(3):489–496.

59.

Mayeres

and Proost

(2001) “Marginal tax reform, externalities and income Distribution”, Journal of Public Economics, 79(2):343–363.

60.

Medina

and Schneider

(2018) “Shadow Economies Around the World: What Did We Learn Over the Last 20 Years?”, IMF Working Papers, WP/18/17.

61.

Musgrave

(1990) “Horizontal equity, once more”, National Tax Journal, 43(2): 113–22.

62.

Musgrave

(1993) “Progressive Taxation, Equity and Tax Design”, Michigan University, Ross School of Business, Office of Tax Policy Research, Product Number WP 1993–9.

63.

Naito

(1999) “Re-examination of uniform commodity taxes under a nonlinear income tax system and its implication for production efficiency”, Journal of Public Economics, 71(2): 165–188.

64.

Nicita

(2004) “Efficiency and Equity of a Marginal Tax Reform: Income, Quality and Price Elasticities for Mexico”, World Bank Policy Research Working Paper 3266.

65.

Peitz

and Reisinger

(2014) “Indirect taxation in vertical oligopoly”, The Journal of Industrial Economics, 62(4): 709–755.

66.

Pencavel

J. H.

(1979) “A note on income tax evasion, labour supply and nonlinear tax schedules”, Journal of Public Economics, 12(1): 115–124.

67.

Piketty

and Saez

(2012) “Optimal labour income taxation”, NBER Working paper series, Working Paper 18521.

68.

Piketty

and Saez

(2013) “A theory of optimal inheritance taxation”, Econometrica, 81(5):1851–1886.

69.

Pyle

D. J.

(1989) Tax Evasion and the Black Economy, London: MacMillan.

70.

Pyle

D. J.

(1991) “The economics of taxpayer compliance”, Journal of Economic Surveys, 5(2):163–198.

71.

Richter

and Boadway

(2005) “Trading off tax distortion and tax evasion”, Journal of Public Economic Theory, 7(3):361–381.

72.

Saez

(2001) “Using elasticities to derive optimal income tax rates”, Review of Economic Studies, 68(1):205–229.

73.

Saez

(2004) “Direct or indirect tax instruments for redistribution: short-run versus long-run”, Journal of Public Economics, 88(3–4):503–518.

74.

Sandmo

(1981) “Income tax evasion, labour supply, and the equity-efficiency tradeoff”, Journal of Public Economics, 16(3):265–288.

75.

Sandmo

(2005) “The theory of tax evasion: A retrospective view”, National Tax Journal, 58(4):643–663.

76.

Shlicht

(1985) “The shadow economy and morals: A note”, 15(1):265–271, in: Gaertner

, Wenig

(eds) The Economics of the Shadow Economy. Studies in Contemporary Economics, Springer, Berlin, Heidelberg.

77.

Skinner

and Slemrod

(1985) “An economic perspective on tax evasion”, National Tax Journal, 38(3):345–353.

78.

Smart

(2002) “Reforming the Direct–Indirect Tax Mix”, International Tax and Public Finance, 9(2):143–155.

79.

Song

Y. D.

and Yarbrough

T. E.

, (1978) “Tax ethics and taxpayer attitudes: A survey”, Public Administration Review, 38(5):442–452.

80.

Sørensen

(1994) “From the global income tax to the dual income tax: Recent tax reforms in the Nordic countries”, International Tax and Public Finance, 1(1):57–79.

81.

Spicer

M. W.

and Becker

L. A.

(1980) “Fiscal inequity and tax evasion: An experimental approach”, National Tax Journal, 33(2):171–175.

82.

Srinivasan

T. N.

(1973) “Tax evasion: A model”, Journal of Public Economics, 2(4):339–346.

83.

Thurman

(1988) “Taxpayer non-compliance and attribution theory: An experimental vignette approach”, Public Finance, 43(1): 147–156.

84.

Truyts

(2012) “Signaling and indirect taxation”, Journal of Public Economics, 96(3–4):331–340.

85.

Vaillancourt

(1989) “The administrative and compliance costs of the personal income tax and payroll tax system in Canada”, Canadian Tax Paper, 86, Canadian Tax Foundation.

86.

Virmani

(1989) “Indirect tax evasion and production efficiency”, Journal of Public Economics, 39(2):223–237.

87.

Wang

, Hubacek

, Feng

, Wei

Y.-M.

And Liang

Q.-M.

(2016) “Distributional effects of carbon taxation”, Applied Energy, 184(1): 1123–1131.

88.

Wang

X.-H.

and Zhao

(2009) “On the efficiency of indirect taxes in differentiated oligopolies with asymmetric costs”, Journal of Economics, 96(3):223–239.

89.

Waud

(1988) “Tax aversion, optimal tax rates and indexation”, Public Finance, 43(2):310–325.

90.

Witte

A. D.

and Woodbury

D. F.

(1985) “The effect of tax laws and tax administration on tax compliance: The case of the US individual income tax”, National Tax Journal, 38(1): 1–13.

91.

Yitzhaki

(1974) “Income tax evasion: A theoretical analysis”, Journal of Public Economics, 3 (2): 201–202.

92.

Yitzhaki

, and Mayshar

(1995) “Dalton-Improving Indirect Tax Reform”, American Economic Review, 85(4):793–807.