Tax evasion and public expenditures on tax revenue services in an endogenous growth model

This paper analyzes the relationship between tax evasion and the two main policy instruments affecting tax compliance, namely, the announced tax rate and the share of tax revenues allocated to tax monitoring mechanisms. For doing so, we adopt a simple one-sector endogenous growth model modified under tax evasion following the Roubini and Sala-i-Martin (1995) analysis on income taxes and tax compliance. Our model confirms Barro׳s (1990) theoretical finding stating that the optimal tax rate is equal to the elasticity of public capital. However, introducing a welfare function where governments care also about the degree of fiscal corruption in the economy, the effective tax rate is lower than the output elasticity of public capital in line with Futagami et al. (1993) and Turnovsky (1997) theoretical results. Finally, our model is calibrated using data on tax evasion from 35 OECD and 110 non-OECD countries for 2011. Simulation results suggest that both tax evasion and output growth are decreasing with the share of tax revenues allocated to monitoring expenses, while government׳s utility maximization imply an announced tax rate lower from the elasticity of public capital for both groups of countries.