Journal of Economic Theory and Econometrics: Journal of the Korean Econometric Society
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Journal of Economic Theory and Econometrics
JETEM/계량경제학보/計量經濟學報/JKES
Journal of the Korean Econometric Society

Tax Avoidance and Excess Burden of Income Tax

Vol.32, No.3, September , 69–93



  •   (Sangmyung University)

  •   (Roger Williams University)

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Abstract  

Our main objective in this paper is to show that income taxation creates an extra burden or distortion when tax avoidance is available. We present a labor supply model with endogenous asset portfolio choice and show that tax avoidance by trading assets impacts labor supply response and total excess burden of income tax. In our model individuals are allowed to change their asset portfolio to reduce their tax liabilities, and this distortion is the main source of the higher efficiency cost in our model. Furthermore, we show that ignoring the avoidance responses leads to biased results when estimating the labor supply distortion and welfare cost of a tax reform. Progressivity of a given tax system is predicted to be less than the formal tax code due to tax avoidance through tax arbitrage.


Keywords
   Asset Choice, Tax Avoidance, Excess Burden, Tax Arbitrage, Progressivity

JEL classification codes
   H2, H21, J22, G11
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