Tax evasion under market incompleteness

Abstract

The available empirical evidence suggests that the distribution of income and its composition play an important role in explaining tax noncompliance. We address the issue from a macroeconomic point of view, building a dynamic general equilibrium BewleyHuggett-Aiyagari model that jointly endogenizes tax evasion and income heterogeneity. Our results show that the model can successfully replicate the salient qualitative and quantitative features of U.S. data. In particular, the model replicates fairly well the shape of the cross-sectional distribution of misreporting rates over true income levels. Furthermore, we show that a switch from progressive to proportional taxation has important quantitative e¤ects on noncompliance rates and tax revenues.