with Christos Kotsogiannis

Abstract: This paper studies personal income-tax evasion in a quantitative life-cycle incomplete-markets setting with heterogeneous agents. A central aspect is that, realistically, evaded taxes are a form of contingent debt. Since evasion becomes part of a portfolio decision, risk considerations and liquidity constraints play a central part. The model, calibrated to match estimated average levels of evasion, does a good job in producing observed cross-sectional average evasion rates that decline with age and with earnings. The model also delivers implications for how evasion varies in the cross sectional distribution of wealth and tax arrears. Evasion has substantial effects on macroeconomic variables and welfare, and agent heterogeneity and general equilibrium are important elements in the explanation. The analysis also considers the response of evasion to a flat-tax policy reform. In spite of the direct incentives to evade less under a flat tax rate, the reform causes households to save more, rendering the change in overall evasion modest.

Working paper - updated December 2020