This paper analyzes a randomized tax enforcement experiment in Denmark. In the base year, a stratified and representative sample of over 40,000 individual income tax filers was selected for the experiment. Half of the tax filers were randomly selected to be thoroughly audited, while the rest were deliberately not audited. The following year, "threat-of-audit" letters were randomly assigned and sent to tax filers in both groups. Using comprehensive administrative tax data, we present four main findings. First, we find that the tax evasion rate is very small (0.3%) for income subject to third-party reporting, but substantial (37%) for self-reported income. Since 95% of all income is third-party reported, the overall evasion rate is very modest. Second, using bunching evidence around large and salient kink points of the nonlinear income tax schedule, we find that marginal tax rates have a positive impact on tax evasion, but that this effect is small in comparison to avoidance responses. Third, we find that prior audits substantially increase self-reported income, implying that individuals update their beliefs about detection probability based on experiencing an audit. Fourth, threat-of-audit letters also have a significant effect on self-reported income, and the size of this effect depends positively on the audit probability expressed in the letter. All these empirical results can be explained by extending the standard model of (rational) tax evasion to allow for the key distinction between self-reported and third-party reported incomes.

This article compares the effects of increasing traditional welfare to introducing in-work benefits in the 15 (pre-enlargement) countries of the European Union. We use a labour supply model encompassing responses to taxes and transfers along both the intensive and extensive margins, and the EUROMOD microsimulation model to estimate current marginal and participation tax rates. We quantify the equity-efficiency trade-off for a range of elasticity parameters. In most countries, because of large existing welfare programmes with high phase-out rates, increasing traditional welfare is undesirable unless the redistributive tastes of the government are extreme. In contrast, the in-work benefit reform is desirable in a very wide set of cases. Copyright 2007 The Author(s). Journal compilation Royal Economic Society 2007.

This paper presents a simple agency model to explain why third-party income reporting by employers dramatically improves income tax enforcement. Modern firms have a large number of employees and carry out complex production tasks, which requires the use of accurate business records. Because such records are widely used within the firm, any single employee can denounce collusive tax cheating between employees and the employer by revealing the true records to the government. We show that, if a firm is large enough, such whistleblowing threats will make tax enforcement successful even with low penalties and low audit rates. Embedding this agency model into the standard Allingham-Sandmo tax evasion model, we show that third-party reporting improves tax enforcement if the government disallows self-reported losses or audits such losses more stringently, which fits with actual tax policy practices. We also embed the agency model into a simple macroeconomic growth model where the size of firms grows with exogenous technological progress. In early stages of development, firms are small, tax rates are severely constrained by enforcement, and the size of government is too small. As firm size increases, the enforcement constraint is slackened, and government size is growing. In late stages of development, firm size is sufficiently large to make third-party tax enforcement completely effective and government size is socially optimal.

This paper analyzes the optimal income tax treatment of couples. Each couple is modelled as a single rational economic agent supplying labor along two dimensions: primary and secondary earnings. We consider fully general joint income tax systems. Separate taxation is never optimal if social welfare depends on total couple incomes. In a model where secondary earners make only a binary work decision (work or not work), we demonstrate that the marginal tax rate of the primary earner is lower when the spouse works. As a result, the tax distortion on the secondary earner decreases with the earnings of the primary earner and actually vanishes to zero asymptotically. Such negative jointness is optimal because redistribution from two-earner toward one-earner couples is more valuable when primary earner income is lower. We also consider a model where both spouses display intensive labor supply responses. In that context, we show that, starting from the optimal separable tax schedules, introducing some negative jointness is always desirable. Numerical simulations suggest that, in that model, it is also optimal for the marginal tax rate on one earner to decrease with the earnings of his/her spouse. We argue that many actual redistribution systems, featuring family-based transfers combined with individually-based taxes, generate schedules with negative jointness.

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A large literature evaluating the welfare effects of taxation has examined the role of the labor supply elasticity, and has shown that the estimated welfare effects are highly sensitive to its size. A common feature of this literature is its exclusive focus on hours worked and the associated marginal tax rate. An emerging consensus among public finance and labor economists, however, is that labor supply is more responsive along the extensive margin (participation) than along the intensive margin (hours worked). To understand the implications of the participation decision for the welfare analysis of tax reform, this paper embeds the extensive margin in an explicit welfare theoretic framework. It is shown that the participation effect on welfare is created by a different tax wedge than the marginaltax wedge relevant for hours of work. This difference is due to non-linearities and discontinuities in tax-transfer schemes, features that are particularly important for the welfare evaluation of tax reforms affecting the bottom of the income distribution. We apply our framework to examine the labor supply and welfare effects for single mothers in the United States following four tax acts passed in 1986, 1990, 1993, and 2001. Our simulations show that each of the four tax acts reduced the tax burden on low-income single mothers, and created substantial welfare gains. We note three features of the welfare effects. First, we find that welfare gains are almost exclusively concentrated along the extensive margin of labor supply. Second, welfare effects along the extensive margin tend to dominate those along the intensive margin, even when the two labor supply elasticities are of similar size. This occurs because the welfare effect on each margin is created by a different tax wedge. Finally, ignoring the composition of the labor supply elasticity may reverse the sign of the welfare effect. In the welfare evaluation of tax reform, we conclude that the composition of the total labor supply elasticity is as important as its size.

A large literature evaluating the welfare effects of taxation has examined the role of the labor supply elasticity, and has shown that the estimated welfare effects are highly sensitive to its size. A common feature of this literature is its exclusive focus on hours worked and the associated marginal tax rate. An emerging consensus among public finance and labor economists, however, is that labor supply is more responsive along the extensive margin (participation) than along the intensive margin (hours worked). To understand the implications of the participation decision for the welfare analysis of tax reform, this paper embeds the extensive margin in an explicit welfare theoretic framework. It is shown that the participation effect on welfare is created by a different tax wedge than the marginaltax wedge relevant for hours of work. This difference is due to non-linearities and discontinuities in tax-transfer schemes, features that are particularly important for the welfare evaluation of tax reforms affecting the bottom of the income distribution. We apply our framework to examine the labor supply and welfare effects for single mothers in the United States following four tax acts passed in 1986, 1990, 1993, and 2001. Our simulations show that each of the four tax acts reduced the tax burden on low-income single mothers, and created substantial welfare gains. We note three features of the welfare effects. First, we find that welfare gains are almost exclusively concentrated along the extensive margin of labor supply. Second, welfare effects along the extensive margin tend to dominate those along the intensive margin, even when the two labor supply elasticities are of similar size. This occurs because the welfare effect on each margin is created by a different tax wedge. Finally, ignoring the composition of the labor supply elasticity may reverse the sign of the welfare effect. In the welfare evaluation of tax reform, we conclude that the composition of the total labor supply elasticity is as important as its size.

We thank our discussant at the AEA 2016 meeting Kathleen McGarry as well as numerous seminar and workshop participants for comments and discussion. Financial support from the Economic Policy Research Network (EPRN) and the Danish Council for Independent Research (DFF-1329-00046) is gratefully acknowledged. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.