Rotterdam Brown Bag Seminars General Economics

Aart Gerritsen (Erasmus University Rotterdam)
Wednesday, 18 April 2018

Abstract: In order to detect tax evasion, tax authorities increasingly make use of third-party reported information on taxpayers’ wealth as well as certain consumption expenditures. When consumption or changes in wealth cannot be justified by self-reported income, the tax authority may decide to initiate an audit. I determine the consequences of such audit policies for the optimal tax structure. In particular, I identify under what conditions third-party reported consumption should be subject to higher (or lower) tax rates than non-reported consumption. On the one hand, as sophisticated tax evaders shy away from third-party reported consumption, raising taxes on unreported consumption may discourage tax evasion. On the other hand, imposing a higher tax on reported consumption further distorts a tax evader’s consumption bundle, and may therefore also discourage tax evasion. The net balance of these countervailing social-welfare effects is crucially driven by the elasticity of substitution between reported and non-reported goods. Government should impose higher (lower) taxes on third-party reported consumption or wealth when the elasticity of substitution is sufficiently high (low). Implications for wealth taxation are discussed.