An OLG Model of Tax Evasion with Public Capital
The paper presents a dynamic overlapping generations model of tax evasion where government revenue is used to provide public capital. It establishes existence and uniqueness of the competitive equilibrium and presents a detailed characterization of its dynamics. An increase in the probability of being caught, and the penal tax rate reduces tax evasion along the entire equilibrium path - a result that holds in the existing models in the literature across steady states. In the extended small open economy model with tariff on imported capital, distortions due to tax evasion wipe out the gains from the tariff reform.
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