Tax Evasion, Technology Shocks, and the Cyclicality of Government Revenues

This paper analyzes the behavior of the tax revenue to output ratio over the business cycle. In order to replicate the empirical evidence, we develop a simple model combining the standard Ak growth model with the tax evasion phenomenon. When individuals conceal part of their true income from the tax authority, they face the risk of being audited and hence of paying the corresponding …ne. Under the empirically plausible assumptions that the intertemporal elasticity of substitution exhibits a su¢ ciently small value and that productivity shocks are serially correlated, we show that the elasticity of government revenue with respect to output is larger than one, which agrees with the empirical evidence. This result holds even if the tax system displays ‡at tax rates. We extend the previous setup to generate larger …scal de…cits when the economy experiences a recession. JEL Classi…cation Number: H23, H26, O41 Keywords: Tax evasion, Technology shocks, Growth Financial support to both authors from the Spanish Ministry of Education through grant ECO200909847 and the Generalitat of Catalonia through grant SGR2009-00350 and, to the …rst author from the ICREA Academia program, is also gratefully acknowledged. Correspondence address: Jordi Caballe. Universitat Autònoma de Barcelona. Departament d’Economia i d’Història Econòmica. Edi…ci B. 08193 Bellaterra (Barcelona). Spain. E-mail: [email protected]