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Optimal dynamic tax evasion: A portfolio approach

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  • Levaggi, Rosella
  • Menoncin, Francesco

Abstract

Most tax evasion models are set in a timeless environment, though this is not suitable for a study of revenues from financial activities where tax evasion occurs in a dynamic environment. This study examines a representative agent aiming to maximize the expected utility from inter-temporal consumption and could invest in both riskless and risky assets, through tax evasion is possible only in the latter case. The investor must pay a fine when his/her evasion is detected (with a given probability). We show that: (i) optimal consumption is higher with tax evasion, (ii) optimal evasion is affected by neither the return nor the volatility of the risky asset, (iii) evasion reduces investment in the risky asset and increases investment in the riskless asset, (iv) evasion can be reduced more efficiently by increasing the fine rather than by increasing the frequency of controls, (v) for a sufficiently high tax rate on the riskless asset, the optimal evasion is zero, and (vi) if the fine is proportional to the amount of taxes, for only sufficiently low fines the Yitzhaki (1974) paradox is confirmed.

Suggested Citation

  • Levaggi, Rosella & Menoncin, Francesco, 2016. "Optimal dynamic tax evasion: A portfolio approach," Journal of Economic Behavior & Organization, Elsevier, vol. 124(C), pages 115-129.
  • Handle: RePEc:eee:jeborg:v:124:y:2016:i:c:p:115-129
    DOI: 10.1016/j.jebo.2015.09.003
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    References listed on IDEAS

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    Cited by:

    1. Domenico De Giovanni & Fabio Lamantia & Mario Pezzino, 2018. "Evolutionary Tax Evasion and Optimal Regulation," Economics Discussion Paper Series 1814, Economics, The University of Manchester.
    2. Giovanni, Domenico De & Lamantia, Fabio & Pezzino, Mario, 2019. "A behavioral model of evolutionary dynamics and optimal regulation of tax evasion," Structural Change and Economic Dynamics, Elsevier, vol. 50(C), pages 79-89.
    3. Rosella Levaggi & Francesco Menoncin, 2015. "Dynamic Tax Evasion with Audits based on Conspicuous Consumption," Working papers 33, Società Italiana di Economia Pubblica.
    4. Francesco Menoncin & Andrea Modena & Luca Regis, 2022. "Dynamic Tax Evasion and Capital Misallocation in General Equilibrium," Carlo Alberto Notebooks 679 JEL Classification: E, Collegio Carlo Alberto.
    5. Pengfei Luo & Yong Ma, 2021. "Robustly dynamic tax evasion and consumption with preferences for cash," International Review of Finance, International Review of Finance Ltd., vol. 21(3), pages 1078-1088, September.
    6. Koo, Ja Eun & Lim, Byung Hwa, 2021. "Consumption and life insurance decisions under hyperbolic discounting and taxation," Economic Modelling, Elsevier, vol. 94(C), pages 288-295.
    7. Rosella Levaggi & Francesco Menoncin, 2016. "Dynamic tax evasion with audits based on visible consumption," Journal of Economics, Springer, vol. 119(2), pages 131-146, October.
    8. Ma, Yong & Jiang, Hao & Xiao, Weilin, 2021. "Tax evasion, audits with memory, and portfolio choice," International Review of Economics & Finance, Elsevier, vol. 71(C), pages 896-909.

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    More about this item

    Keywords

    Dynamic tax evasion; Asset allocation; Dynamic programming; Poisson process;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • H42 - Public Economics - - Publicly Provided Goods - - - Publicly Provided Private Goods

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