Tax evasion and debt in a dynamic general equilibrium model

Abstract

The literature has long analysed optimal taxation policies in economies where tax evasion is widespread. Nevertheless, very little has been produced on the relationship between public debt, tax evasion, and long-term economic growth. In this article, we investigate the relationship between sovereign debt sustainability and tax evasion by computing under which conditions the debt/GDP ratio is endogenously mean reverting in the context where tax evasion may increase the public debt and public expenditure is used to finance public and merit goods. For a log utility consumer, the level of tax evasion has no effect on the mean reverting conditions while the same is not true for more general functional forms. Finally, we conclude that allowing for tax evasion is not a suitable policy to make the debt/GDP ratio stable over time, especially in low-growth economies.