Tax Evasion under Market Incompletenss

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 Bewley model that jointly endogenizes the determinants of tax evasion and income heterogeneity. Our results show that the model can successfully replicate the salient qualitative and quantitative features of the 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 effects on noncompliance rates and tax revenues.