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The optimal tax mix with underground labor

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  • Alejandro Forcades

    (Universitat Autònoma de Barcelona)

Abstract

The optimal mix between capital, labor and consumption taxes is derived in a model with underground labor. The Ramsey planner, which is limited by the trade-off between declared and underground labor, sets the tax rate on labor income equal to zero in order to get rid off the issue of tax evasion; so, in contrast to Coleman (2000), subsidizing labor is not optimal. This paper also points out that adding consumption taxation to the model of Correia (1992) makes the Chamley-Judd result of a zero capital tax in the long run hold even when there are restrictions on the taxation of labor; in fact, the optimal tax rate on capital income is always zero. Since consumption taxes are positive and constant for each period, I provide an alternative argument to shift the whole tax burden from income to consumption.

Suggested Citation

  • Alejandro Forcades, 2019. "The optimal tax mix with underground labor," Economics Bulletin, AccessEcon, vol. 39(1), pages 214-222.
    • Handle: RePEc:ebl:ecbull:eb-18-00474
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    References listed on IDEAS

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    1. Renzo Orsi & Davide Raggi & Francesco Turino, 2014. "Size, Trend, and Policy Implications of the Underground Economy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 417-436, July.
    2. Francesco Busato & Bruno Chiarini, 2004. "Market and underground activities in a two-sector dynamic equilibrium model," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 23(4), pages 831-861, May.
    3. Laczó, Sarolta & Rossi, Raffaele, 2020. "Time-consistent consumption taxation," Journal of Monetary Economics, Elsevier, vol. 114(C), pages 194-220.
    4. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-622, May.
    5. Correia, Isabel H., 1996. "Should capital income be taxed in the steady state?," Journal of Public Economics, Elsevier, vol. 60(1), pages 147-151, April.
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    Keywords

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    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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