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Combining optimal tax evasion with the policy objectives of equity/efficiency

Author: BASIL DALAMAGAS, JOHN LEVENTIDES AND STEFANOS TANTOS
Published in PFM, Vol. 19 No. 1

The equity/efficiency tradeoff is a fairly extensive topic in economic literature. A large body of work has concentrated efforts on a variety of relevant issues, such as the determining factors of equity and efficiency and the potentially damaging economic consequences in terms of government failure in choosing the proper mix of fiscal ob-jectives. However, no attempt has been made so far to use adjustments in tax rates in order to define an optimal equity/efficiency level that could be combined with the government’s aim of playing a more prominent role in promoting the optimal fiscal policy objectives. In the present study, we find that changes in direct/indirect tax rates are capable of affecting not only the optimal level of evasion but also the optimal policy goals of equity/efficiency. To this end, a theoretical optimization model is con-structed, the first-order conditions are properly manipulated and simulations are con-ducted to determine optimal evasion and optimal allocation of resources to the fiscal objectives of equity and/or efficiency. Τhe model is empirically tested by employing data from 35 countries over the period 2007-2015.

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