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Tax evasion and the optimal non-linear labour income taxation

Working Paper 2015-373

Abstract

The present work studies optimal taxation of labour income when taxpayers are allowed to evade taxes. The analysis is conducted within a general non-linear tax framework, providing a characterisation of the solution for risk-neutral and risk-averse agents. For risk-neutral agents the optimal government choice is to enforce no evasion and to apply the original Mirrlees’ rule for the optimal tax schedule. The no evasion condition is precisely determined by a combination of a sufficiently large penalty and a constant auditing probability. Similar results hold for risk-averse agents. Our findings imply that a government aiming at maximizing social welfare should always enforce no evasion and

Authors: Salvador Balle, Lucia Mangiavacchi, Luca Piccoli, Amedeo Spadaro.

Keywords: Tax evasion, optimal taxation, social welfare.
JEL: H21, H26, H31.