Tax evasion and occupational choice

Abstract

This paper is concerned with the combined effect of tax compliance and tax audit policy on the occupational choice of individuals and on public policy objectives such as tax revenue, total production, and social welfare. Individuals are assumed to have a choice between riskless work and a risky entrepreneurial occupation. They are only differentiated according to their attitudes towards risk. More risk averse individuals go into the safe occupation and less risk averse people become entrepreneurs. Tax evasion is only accessible to the latter and therefore its control tends to discourage risk taking. Whether control of tax evasion is desirable for the economy as a whole depends on the objective function of the government. It is shown that tax audit policy has conflicting effects on tax revenue, per capita income, and social welfare. These conflicts are illustrated through a numerical example. In this paper, the emphasis is placed on the clarity and the simplicity of the presentation so as to argue that, even though the tax schedule can hardly be differentiated across individuals, tax evasion and its control can be used by policymakers to introduce variability in the individual's tax treatment.