Tax Evasion, Redistribution and Inequality: Observed, Actual and Potential Effects

The data we compute or have available on how the Personal Income Tax (PIT) contributes to reducing inequality in the distribution of income among individuals or households are usually based on reported income and the tax actually paid by taxpayers. In the presence of evasion, however, these results do not correspond to reality, because reported income does not coincide with the income actually earned by taxpayers. In this paper we show that, if the elasticity of evasion with respect to individuals’ true income is greater than or equal to one, the “actual” inequality of income after the PIT (that is, inequality measured in relation to true income rather than to the income reported by taxpayers) exceeds “observed” inequality (that computed with reported income). We also discuss the conditions under which actual inequality exceeds “potential” inequality (the inequality that would obtain in the absence of evasion in the PIT), as well as the relationship between potential and observed inequality.