Tax Avoidance and Evasion in a Dynamic Setting

Abstract

We study tax avoidance and tax evasion in an intertemporal utility maximization problem where evasion is fined if discovered, while avoidance is costly but entails a reduced payment upon audit (avoidance premium). We find that traditional deterrence instruments (fine and frequency of audit) reduce optimal evasion but, in contrast with results in a static framework, they have no impact on optimal avoidance. Instead, tax avoidance depends negatively on its marginal cost and positively on both the tax rate and the avoidance premium. Our model shows that non-compliance behavior may result in a Laffer curve for fiscal revenues and that the revenue maximizing tax rate is lower the higher the avoidance premium. We characterize the optimal level of the avoidance premium by taking into account different government objectives: minimizing evasion, minimizing non-compliance (evasion plus avoidance), and maximizing revenues. Our results suggest that specific policies need to be implemented in order to deter avoidance (e.g., tax simplification) and we illustrate their impact on evasion

Publication
Working Paper
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