Taxes are major source of public funds to finance government expenditures. Taxauthorities impose different kind of taxes and employ many agents to collect taxeseffectively. Some dutiful taxpayers will undoubtedly pay their tax liabilities whilemany others will not. The Internal Revenue Service in the United States reportsthat the estimate of income tax liability not collected is about 17, which translatesinto 345 billion for 2001. It is important to make a distinction between tax evasionand tax avoidance. The distinguishing characteristic of evasion is illegality. Whetherthe reason for not paying tax liability is avoidance or evasion, economic models oftaxation need to be changed in the light of these realities. In this study, I analyzesome of the economic problems of tax evasion/avoidance.In the first chapter, I discuss the relationship between number of tax audits,tax administration reform and tax compliance in Turkey. In recent years, manydeveloping countries have carried out reforms in their tax administration to increasetheir efficiency in collecting taxes. In 2005, the tax authority in Turkey establishedTax Office Directorates (T.O.D.s) in 29 provinces for the purpose of controlling the underground economy, improving taxpayer assistance, and increasing auditingefficiency. By using the panel data on province level tax returns, my analysis answerstwo questions. First, I examine the effect of audits on reported income and reportedtax liability. By controlling for the detectibility of evasion and other socioeconomicvariables, I find that audits have the same effectiveness in increasing reported incomeand reported tax liability. Second, I investigate the effect of establishing T.O.D.s in29 provinces on compliance in those provinces. I find that T.O.D.s are effective at theextensive margin rather than the intensive margin. Thus, establishing T.O.D.s hadno significant effect on the compliance level of existing taxpayers while it increasedthe number of tax returns significantly.In the second chapter, I analyze the excess burden on income tax when taxavoidance matters. I present a simple static labor supply model with endogenousasset choice. Then, I examine how tax avoidance through asset trading a ects thelabor supply response and the excess burden of income tax. Furthermore, I discussthe implications of the tax policy analysis and show that a failure to account foravoidance responses may lead to errors when estimating how tax reform affects laborsupply, tax revenue, and the welfare cost of taxation. Because of tax avoidancethrough tax arbitrage, the progressivity of a given tax system will be less than whatthe formal tax system implies.In the third chapter,we study the Marginal Cost of Funds in the existence oftax evasion. We develop a general equilibrium model of tax evasion, including theexpected utility of taxpayers and three different revenue-raising government policies.In this rich model environment, we analytically derive the marginal cost of funds (MCF) for the alternative policy instruments. We consider two main fiscal reforms:the revision in the nonlinear tax scheme and the changes in enforcement mechanism(the audit and penalty rates). First, we derive the MCF for the tax reform and findits key determinants. The derived MCF is greater than the previous ones since itincludes a "risk-bearing cost" as well as tax distortion. The reform in enforcementmechanism generates MCFs in different forms. Two more MCFs with respect toaudit and penalty rates are presented. Finally, we compare these three differentMCFs in numerical example and provide some policy implications.