Mobility, competition, and the distributional effects of tax evasion

The standard assumption underlying the incidence of tax evasion is that the beneficiaries are those who successfully evade their taxes. However, a general equilibrium process of adjustment should occur in response to tax evasion, involving changes in the relative prices of both commodities and factors of production as resources move into and out of the relevant activities, and these changes should tend to reduce any initial benefi t from evasion. In this paper we analyze these incidence effects, using a computable general equilibrium model of an economy with a formal (and taxed) sector and an informal (and untaxed) sector, in order to examine how much of the initial benefi t of income tax evasion is retained by the evaders and how much is shifted via factor and commodity price changes stemming from mobility. Our simulation results show that the household that successfully evades its income tax liabilities has a post-evasion welfare that is only slightly higher than its post-tax welfare if it had fully complied with taxes. Further, while this household keeps some of its initial increase in welfare, a large percentage of this initial gain is competed away as a result of mobility that refl ects competition and entry into the informal sector. Consequently, the evading household benefi ts only marginally from successful income tax evasion, and this advantage diminishes with mobility via competition/ entry in the informal sector.