Tax evasion and consumption indivisibility

Given the fairly common fact of indivisible-good consumption, this paper investigates the role played by consumption indivisibility in a tax evasion model. It is shown that, in the presence of consumption indivisibility, some risk-averse taxpayers may act like risk lovers, engaging in tax evasion even in a less-than-fair game. Thus, the required audit rates and penalties for deterring tax evasion are higher than those in the traditional tax evasion model without consumption indivisibility. In addition, based on the finding that some taxpayers participate in the evasion game with a negative expected payoff, an appropriate relaxation in tax enforcement (by lowering the audit or penalty rate) can increase the government’s tax revenues and social welfare. In other words, the existence of some degree of tax evasion is socially optimal.