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Tax Collection Costs, Tax Evasion and Optimal Interest Rates

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  • Pinar Yesin

    ()
    (Studienzentrum Gerzensee and Swiss National Bank)

Abstract

In this paper, I investigate to what extent the cross-country variation in nominal interest rates can be explained as being due to governments' optimal response to economic conditions such as tax collection costs, tax evasion and government consumption needs. In particular, I study the effects of costly income taxes in the presence of an informal sector on the solution to a Ramsey problem in a general equilibrium framework. Unlike most of the previous analyses of optimal inflationary finance, the model postulates that conventional taxes carry collection costs whereas fiat money can be printed costlessly. For some countries, I measure tax collection costs, use the tax evasion estimates reported in the literature, and then calculate the optimal interest rate based on the model. Comparison of the actual and optimal interest rates demonstrates that the model can in fact partly explain the observed deviations from the Friedman Rule. I also show that allowing cross-country differences in the elasticity of substitution between formal and informal sectors can increase the model's explanatory power.

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Bibliographic Info

Paper provided by Swiss National Bank, Study Center Gerzensee in its series Working Papers with number 04.02.

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Length: 31
Date of creation: May 2004
Date of revision:
Handle: RePEc:szg:worpap:0402

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References

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  1. repec:cup:macdyn:v:7:y:2003:i:3:p:333-62 is not listed on IDEAS
  2. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  3. Johnson, Simon & Kaufmann, Daniel & Zoido-Lobaton, Pablo, 1998. "Regulatory Discretion and the Unofficial Economy," American Economic Review, American Economic Association, vol. 88(2), pages 387-92, May.
  4. Alex Cukierman & Sebastian Edwards & Guido Tabellini, 1989. "Seigniorage and Political Instability," NBER Working Papers 3199, National Bureau of Economic Research, Inc.
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  6. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
  7. Lemieux, Thomas & Fortin, Bernard & Frechette, Pierre, 1994. "The Effect of Taxes on Labor Supply in the Underground Economy," American Economic Review, American Economic Association, vol. 84(1), pages 231-54, March.
  8. Isabel Correia & Pedro Teles, 1997. "The optimal inflation tax," Discussion Paper / Institute for Empirical Macroeconomics 123, Federal Reserve Bank of Minneapolis.
  9. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March.
  10. Click, Reid W, 1998. "Seigniorage in a Cross-Section of Countries," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(2), pages 154-71, May.
  11. Schneider, Friedrich, 2002. "The Size and Development of the Shadow Economies of 22 Transition and 21 OECD Countries," IZA Discussion Papers 514, Institute for the Study of Labor (IZA).
  12. Nicolini, Juan Pablo, 1998. "Tax evasion and the optimal inflation tax," Journal of Development Economics, Elsevier, vol. 55(1), pages 215-232, February.
  13. Carlos A. Végh, 1989. "Government Spending and Inflationary Finance: A Public Finance Approach," IMF Staff Papers, Palgrave Macmillan, vol. 36(3), pages 657-677, September.
  14. de V. Cavalcanti, Tiago V. & Villamil, Anne P., 2003. "Optimal Inflation Tax And Structural Reform," Macroeconomic Dynamics, Cambridge University Press, vol. 7(03), pages 333-362, June.
  15. De Fiore, Fiorella, 2000. "The optimal inflation tax when taxes are costly to collect," Working Paper Series 0038, European Central Bank.
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Cited by:
  1. Pinar Ayse Yesin, 2006. "Financing Government Expenditures Optimally," Working Papers 06.01, Swiss National Bank, Study Center Gerzensee.
  2. Satya P. Das, 2011. "The political economy of revenue pressure and tax collection efficiency," Indian Growth and Development Review, Emerald Group Publishing, vol. 4(1), pages 38-52, April.

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