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Tax Evasion, Technology Shocks, and the Cyclicality of Government Revenues

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  • Jordi Caballé
  • Judith Panadés

Abstract

This paper analyzes the behavior of the tax revenue to output ratio over the business cycle. In order to replicate the empirical evidence, we develop a simple model combining the standard Ak growth model with the tax evasion phenomenon. When individuals conceal part of their true income from the tax authority, they face the risk of being audited and hence of paying the corresponding fine. Under the empirically plausible assumptions that the intertemporal elasticity of substitution exhibits a sufficiently small value and that productivity shocks are serially correlated, we show that the elasticity of government revenue with respect to output is larger than one, which agrees with the empirical evidence. This result holds even if the tax system displays flat tax rates. We extend the previous setup to generate larger fiscal deficits when the economy experiences a recession.

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 546.

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Date of creation: Apr 2011
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Handle: RePEc:bge:wpaper:546

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Keywords: Tax evasion; Technology shocks; Growth;

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  1. Gabriela Inchauste & Bernardin Akitoby & Benedict J. Clements & Sanjeev Gupta, 2004. "The Cyclical and Long-Term Behavior of Government Expenditures in Developing Countries," IMF Working Papers, International Monetary Fund 04/202, International Monetary Fund.
  2. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
  3. Talvi, Ernesto & Vegh, Carlos A., 2005. "Tax base variability and procyclical fiscal policy in developing countries," Journal of Development Economics, Elsevier, Elsevier, vol. 78(1), pages 156-190, October.
  4. Donald Bruce & William F. Fox & M.H. Tuttle, 2006. "Tax Base Elasticities: A Multi-State Analysis of Long-Run and Short-Run Dynamics," Southern Economic Journal, Southern Economic Association, Southern Economic Association, vol. 73(2), pages 315–341, October.
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