Tax Evasion, Inequality and Progressive Taxes: A Political Economy Perspective Joseph

This paper revisits the original Allingham and Sandmo (1972) framework with a view towards addressing the issue of tax compliance, and examining the political economy implications of tax evasion for progressivity in the tax structure. In so doing, we ‘start from scratch’ by constructing a simple extension of the basic Allingham and Sandmo construct that allows agents to initially decide whether to evade taxes or not. We then use a step-by-step model building procedure by taking both the basic model and its ‘evade-or-not’ counterpart towards a dynamic macroeconomic framework. We find that the 'evade or not' assumption has strikingly different and more realistic implications for the extent of evasion, and demonstrate that it is a more appropriate modeling strategy in the context of macroeconomic models. Furthermore, our numerical analysis suggests that the political outcome for the tax rate for a given level of inequality is conditional on whether there is a large or small or large extent of evasion in the economy, although changes in inequality do not matter for this outcome.