Tax Evasion, Efficiency, and Bunching in the Presence of Enforcement Notches

Abstract

A recent literature has studied bunching at notches in tax systems; but work on the implications of bunching for welfare has been limited. We consider a setting where there are discrete changes in the enforcement of tax compliance at certain levels of reported income, creating notches that can lead to bunching. We find that greater levels of bunching can be associated with greater tax efficiency. A simulation exercise demonstrates that notches with greater bunching can be associated with higher welfare than notches with less bunching, and that a tax system with bunching at a notch can generate higher overall social welfare than a revenue-equivalent no-evasion linear tax. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.