Dimensional traps in evasion models and their effects on industrial structure

Abstract

Size-dependent firms’ monitoring by the state leads to sub-optimal results in terms of combating evasion and efficient allocation of investment by firms. While Coppier, Michetti and Scaccia (2022) describe how such a policy can be a source of dimensional trap in a single-firm evasion model, the present paper moves to a heterogeneous context, considering industrial structures composed of many firms with different sizes. We then propose a discrete-time nondeterministic dynamic model to describe the consequences of size-dependent policies and potential dimensional traps on industrial structure and its evolution over time. We show that an unwise choice of policy parameters may determine a long-run equilibrium industrial structure characterized by a small number of large firms and a plethora of small firms, with the latter being marked by inefficient resource allocation and noncompliant behavior with regard to tax regulations. These results are robust to different choices of the initial industrial structure suggesting alternative policy indications.