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Does tax evasion affect unemployment and educational choice?

Author: Ann-Sofie Kolm, And Birthe Larsen, And

Summary of Working paper 2004:4

To examine the macro economic effects of government tax and
punishment policies, this paper develops a three-sector general equilibrium
model featuring matching frictions, heterogenous abilities
and an informal sector with tax evasion. The choice of education
is determined endogenously. Job opportunities in an informal sector
are available only to workers who choose not to acquire higher
education. We find that increased punishment of informal activities
increases the number of educated workers and reduces the number
of unemployed workers. Characterizing the optimal tax and punishment
system, we show that it is optimal to more than fully counteract
the distortion created by the government’s inability to tax the informal
sector. The optimal choice of tax and punishment system,
however, implies an inefficiently low stock of educated workers.
JEL-codes: H26, I21, J64
Keywords: Tax evasion, underground economy, education, matching,
unemployment.

To examine the macro economic effects of government tax and punishment policies, this paper develops a three-sector general equilibrium model featuring matching frictions, heterogenous abilities and an informal sector with tax evasion. The choice of education is determined endogenously. Job opportunities in an informal sector are available only to workers who choose not to acquire higher education. We find that increased punishment of informal activities increases the number of educated workers and reduces the number of unemployed workers. Characterizing the optimal tax and punishment system, we show that it is optimal to more than fully counteract the distortion created by the government’s inability to tax the informal sector. The optimal choice of tax and punishment system, however, implies an inefficiently low stock of educated workers.

Keywords: Tax evasion, underground economy, education, matching, unemployment.
JEL-codes: H26, I21, J64

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