Public provision of private goods, self-selection and income tax avoidance

Several contributions in the optimal taxation literature have emphasized that, when individuals’ preferences are not separable between leisure and other goods, it is desirable to supplement a nonlinear income tax with public provision of private goods. Moreover, it has also been shown that the choice between a topping-up and an opting-out scheme depends on whether the publicly provided good is a complement or substitute with leisure, with opting-out (topping-up) being the preferred scheme for goods which are substitutes (complements)for labor. In this paper, using the self-selection approach to tax analysis, we revisit these results in the presence of tax avoidance, and investigate how public provision interacts with the agents’incentives to engage in tax avoidance. Three results are obtained. First, we show that tax dodging opportunities imply that non-separability between labor and other goods is neither a necessary nor a sufficient condition to make public provision of private goods a welfare-enhancing policy instrument. Second, we show how tax dodging opportunities limit the scope for using topping-up provision schemes as a redistributive device. Finally, we show that, for most of the public provision schemes previously analyzed in the literature, being a welfare-enhancing policy instrument goes hand in hand with weakening the agents’incentives to shelter income from the tax authority. However, we also point out an important exception to this pattern.