with Christos Kotsogiannis
Abstract
This paper studies income tax evasion by self-employed businesses in a quantitative life-cycle incomplete-markets setting with heterogeneous agents. A central innovative aspect is that, realistically, evaded taxes are a form of contingent debt. Since evasion becomes part of a portfolio decision, intertemporal and risk considerations play an important part. The model, calibrated to match U.S. aggregate average measures of evasion, fits the un-targeted empirical profile of evasion by income, not only qualitatively but also quantitatively. The decreasing pattern of misreporting by reported income quantiles is strikingly similar to that documented on IRS audit data. The misreporting profile by true income accounts for the re-ranking effect also observed in data. It is critical that arrears accumulate with income and wealth, vindicating the innovative elements of this analysis. The model also succeeds in producing evasion rates that decline with working-life age. A counterfactual exercise shows that evasion has substantial effects on macroeconomic variables and welfare.
Latest version (31 December 2024)
Working paper of older version - updated December 2020