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Optimal monetary and audit policy with imperfect taxation

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  • Arbex, Marcelo
  • Turdaliev, Nurlan

Abstract

We study optimal monetary and fiscal policy in the presence of informal activities and tax evasion in a cash-and-credit model where identical households are audited to determine their compliance with the tax code. Taxation of informal labor is imperfect, but the government has tools to deal with informal activities and can choose them optimally to reduce fiscal distortions. We characterize both the optimal monetary (optimal interest rate) and fiscal policy (optimal income tax, evasion penalty and audit probability). When auditing is costless, a nominal interest rate equal to zero is optimal and attained when all agents are audited and both types of labor are taxed at the same rate. In the presence of auditing costs, the optimal audit policy does not follow the Friedman rule, and we report the welfare costs of implementing this monetary policy prescription. We derive conditions under which the Friedman rule can be recovered in an economy with informal activities.

Suggested Citation

  • Arbex, Marcelo & Turdaliev, Nurlan, 2011. "Optimal monetary and audit policy with imperfect taxation," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 327-340, June.
  • Handle: RePEc:eee:jmacro:v:33:y:2011:i:2:p:327-340
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    Cited by:

    1. Elgin, Ceyhun & Solis-Garcia, Mario, 2015. "Tax enforcement, technology, and the informal sector," Economic Systems, Elsevier, vol. 39(1), pages 97-120.
    2. Claudio Cesaroni, 2017. "Optimal Long-Run Inflation and the Informal Economy," Bank of Lithuania Working Paper Series 46, Bank of Lithuania.
    3. Gahvari, Firouz & Micheletto, Luca, 2014. "The Friedman rule in an overlapping-generations model with nonlinear taxation and income misreporting," Journal of Public Economics, Elsevier, vol. 119(C), pages 10-23.

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