The Theoretical Analysis of Income Tax Evasion Revisited

Abstract

There exists an important puzzle in the income tax evasion literature, that higher tax rates unambiguously encourage tax compliance (Yitzhaki’s (1974) result). In this paper I show that by simply relaxing the assumption that higher tax rates necessarily translate into higher penalty payments at the initial optimum when caught, it is possible to generate rigorously an important extra disincentive to compliance, which is absent from the previous works. It can also be shown that Yitzhaki's (1974) result is a special case of the present formulation.