Tax Evasion and Self-Employment Decisions: Evidence from an Income Tax Reform in Chile

This paper studies the causal efect of income tax evasion opportunities on the selfemployment decision. Two peculiarities of the Chilean scheme enable us to identify this efect. First, in the Chilean tax design, self-employed and wage-earners are levied with equal marginal taxes, eliminating the diferential tax efect. We disentangle two channels through an occupational choice model: taxable income and evasion. Second, we exploit a tax reform that exogenously afects agents’ evasion decisions. Following a consumption-based approach, we obtain a tax evasion measure, and estimate two behavioral parameters: (i) the evasion elasticity to marginal tax rate equals 1.4; (ii) an increase of 1 percentage point in the evasion opportunity makes being self-employed 6.1 percentage points more likely. The evasion opportunity is a crucial determinant of the self-employment response to the policy change, mainly driven by agents’ behavior near the frst income bracket. While women-headed households’ evasion behavior is less sensitive to a tax change, having higher education primarily drives this behavior.