Abstract
AbstractWe explore how tax evasion by firms affects the growth- and welfare-maximizing rates of corporate income tax (CIT) in an endogenous growth model with productive public service. We show that the negative effect of CIT on growth is mitigated in the presence of tax evasion. This increases the benefit of raising the CIT rate for public service provision. Thus, in contrast to Barro [(1990)Journal of Political Economy98, 103–125], the optimal tax rate is higher than the output elasticity of public service. Through numerical exercises, we demonstrate that the role of tax evasion by firms is quantitatively significant.
Highlights
Corporate income tax has detrimental effects on investment by firms
We provide the baseline value of announced corporate income tax (CIT) rate, τ = 0.2706, to determine the baseline balanced growth rate because the balanced growth rate depends on τ in this model economy
This study investigates the optimal CIT in an endogenous growth model with productive public services, incorporating tax evasion by monopolistically competitive firms of intermediate goods
Summary
Corporate income tax (hereafter, CIT) has detrimental effects on investment by firms. Some studies (e.g., Futagami et al 1993; Ghosh and Roy 2004; Agenor 2008) show that the welfare-maximizing tax rate is lower than the growth-maximizing one (output elasticity of public capital), while other studies (e.g., Kalaitzidakis and Kalyvitis 2004; Chang and Chang 2015) show the opposite result.8 While these existing studies consider neither CIT nor tax evasion, our study investigates optimal taxation, 7Some empirical studies suggest the importance of productive public expenditure for economic growth. On the other hand, Kafkalas et al (2014) assume that the government’s inspection expenditure is proportional to tax revenues They show that, even with tax evasion, the growth-(and utility-) maximizing effective tax rate equals the output elasticity of public capital, in line with Barro’s rule.
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