Exploring tax evasion in the context of political uncertainty

We present a model of agents facing the uncertainty of two future forms of government who are able to insure against this uncertainty by hiding funds from taxation. In order to choose whether or not to hide funds from taxation, agents need to know policy choices that each government would make should it come to power. But each government, before it could make its decision, would need to know the choices of the agents who would, for example, produce tax revenues. This informational tension is resolved endogenously. We derive the resulting level of tax evasion in society and the optimal choices made by the potential governments. We examine how changes in governmental structure would affect the level of tax evasion, and how that, in turn, would affect a particular form of capital flight. 2013 Elsevier B.V. All rights reserved. * Corresponding author. Tel.: þ1 212 998 0865; fax: þ1 212 995 4218. E-mail addresses: [email protected] (B.G. Katz), [email protected] (J. Owen). 1 Tel.: þ1 212 998 0446; fax: þ1 212 995 4003. 2 See Kornai (2006, Table 4) for the list of the thirty governmental turnovers in these countries between 1990 and 2004. These eight economies in transition were the Czech Republic, Estonia, Poland, Latvia, Lithuania, Hungary, Slovakia and Slovenia. Using the same methodology and countries, and extending the time period to March 2011, we find thirty-nine instances in which incumbents were replaced in a total of fifty-two elections.