DP14984 Welfare improving tax evasion

Author(s): Chiara Canta, Helmuth Cremer, Firouz Gahvari
Publication Date: July 2020
Keyword(s): audits, optimal taxation, tax evasion, welfare-improving
JEL(s): H20, H21, H26
Programme Areas: Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14984

We study optimal income taxation in a framework where one's willingness to report his income truthfully is positively correlated with his type. We show that allowing low-productivity types to cheat leads to Pareto-superior outcomes as compared to deterring them, even if audits can be performed costlessly. When there is no cheating, redistribution takes place on first- and second-best frontiers and can never make low-ability types more well-off than high-ability types. Letting low-ability types cheat allows first-best redistribution up to a limit at which low-ability types are better off than high-ability types.