Tax evasion in a model of endogenous growth

This paper integrates tax evasion into a standard AK growth model with public capital. In the model, the government optimizes the tax rate, while individuals optimize tax evasion. It studies tax rate, tax evasion and economic growth, and compares them with other wise identical economies except those without tax evasion. It inquires into the effects of three government policies on tax rate, tax evasion, and economic growth. It finds that an increase in both unit cost of tax evasion and punishment-fines reduces tax evasion, whereas an increase in tax auditing reduces tax evasion only if the cost of tax enforcement is not too high. The three policies theoretically have ambiguous effects upon economic growth, due to their indirect effects upon tax evasion and optimal tax rate. The model is calibrated to quantitatively assess the effects of the three above-mentioned policies. It finds that the three policies are quantitatively effective in discouraging tax evasion, but with small growth effects, unless the degree of government externality is very high. (C) 2003 Elsevier Science (USA). All rights reserved.