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A New Look at the Laffer Curve and the Displacement Loss from Tax Evasion

  • Filip Palda

    (Ecole nationale d'administration publique in Montreal)

The two most prominent deadweight losses in public finance are the triangle loss from taxation and the rectangle loss from rent-seeking. This paper suggests that a third type of deadweight loss can rival these two in size and deserves detailed exploration. In the presence of the underground economy taxes give rise to a deadweight loss from displacement of efficient producers by inefficient producers. I consider an economy in which a producer faces two types of costs: the cost of production, and taxes. If good evaders are inefficient producers, tax evasion turns a flat tax into a tax based on ability to pay with the result that maximum government revenues possible under tax evasion may be larger than when no one evades taxes. Displacement deadweight loss is a subset of a larger class of losses that arise when productive and counterproductive features are bundled into the same economic agent and when that agent has no incentive or opportunity to specialize wholly in one or the other pursuit.

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Paper provided by EconWPA in its series Public Economics with number 0111006.

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Length: 37 pages
Date of creation: 10 Nov 2001
Date of revision:
Handle: RePEc:wpa:wuwppe:0111006
Note: Type of Document - PDF; prepared on IBM PC ; to print on HP/PostScript/; pages: 37; figures: included. PDF document. Can be viewed or printed.
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  1. Heckman, James J & Honore, Bo E, 1990. "The Empirical Content of the Roy Model," Econometrica, Econometric Society, vol. 58(5), pages 1121-49, September.
  2. Filip Palda, 1998. "Evasive Ability and the Efficiency Cost of the Underground Economy," Canadian Journal of Economics, Canadian Economics Association, vol. 31(5), pages 1118-1138, November.
  3. Joel Slemrod & Shlomo Yitzhaki, 2000. "Tax Avoidance, Evasion, and Administration," NBER Working Papers 7473, National Bureau of Economic Research, Inc.
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