Tax evasion and financial repression

Abstract

Using a simple overlapping generations framework, calibrated to four Southern European countries, we analyze the relationship between tax evasion, determined endogenously, and financial repression. We show that higher degree of tax evasion within a country, resulting from a higher level of corruption and a lower penalty rate, yields higher degrees of financial repression as a social optimum. However, a higher degree of tax evasion, due to a lower tax rate, reduces the severity of the financial restriction.

Tax evasion, financial development and inflation: Theory and empirical evidence

“…Gupta (2008) and Gupta and Ziramba (2009) point out that studies (such as Roubini and Sala-i-Martin (1995), Gupta (2005) and Holman and Neanidis (2006)) which analyse optimal (growth-and/or welfare-maximising) mix of fiscal and monetary policy suffer from the Lucas (1976) critique, by treating tax evasion exogenously. Gupta (2008) and Gupta and Ziramba (2009) reached such conclusions by developing growth models with tax evasion being a behavioural decision (as also pointed out theoretically by Atolia (2003), Chen (2003) and Arana (2004)) to indicate that the level of tax evasion is dependant on the tax and penalty rates. Given this, following a change in the degree of tax evasion, the tax and the penalty rates are not available to the policy maker to respond optimally to such a change, since clearly changes in these policy variables would affect the level of tax evasion further.…”

“…Given this, following a change in the degree of tax evasion, the tax and the penalty rates are not available to the policy maker to respond optimally to such a change, since clearly changes in these policy variables would affect the level of tax evasion further. Thus, Gupta (2008) and Gupta and Ziramba (2009) studies optimal monetary policy response following changes in the degree of tax evasion emanating from not only movements in the structural parameters of the model, but also variations in the tax and penalty rates. 5 Now, with tax evasion also affected by monetary policy, it would imply that the studies of Gupta (2008) and Gupta and Ziramba (2009) is not immune to the Lucas (1976) critique either.…”

“…Thus, Gupta (2008) and Gupta and Ziramba (2009) studies optimal monetary policy response following changes in the degree of tax evasion emanating from not only movements in the structural parameters of the model, but also variations in the tax and penalty rates. 5 Now, with tax evasion also affected by monetary policy, it would imply that the studies of Gupta (2008) and Gupta and Ziramba (2009) is not immune to the Lucas (1976) critique either. In summary, studies that analyse optimal (growthand/or welfare-maximising) monetary and fiscal policy following a change in the degree of tax evasion is likely to lead to non-optimal policy outcomes, since changes in the policy parameters in response to the change in the level from a calibrated dynamic general equilibrium model for various countries over different periods.…”

“…For a detailed discussion along these lines, refer to Gupta (2005Gupta ( , 2008 and Ziramba (2009, 2010).…”

An Endogenous Growth Model of a Financially Repressed Small Open Economy

“…The quantification also helps in indicating the strength of the effect of financial liberalization, emanating both through a higher interest rate on deposits and lower reserve requirements. The following parameter values were chosen initially and the sources are given in the parentheses: 14 the tax rate, τ=0.25 (Gupta, 2008), the reserve requirement, γ=0.15 (Haslag & Young, 1998), the interest rate on the deposits (Gupta, 2008) the elasticity of capital with respect to output, =0.40 (Zimmermann, 1997), the depreciation rate of capital, (Zimmermann, 1997), and the transaction cost parameters c 1 and c 2 =1.0 (Gupta, 2008). The value of A, the production function scalar, is calibrated from the equilibrium conditions to match a growth rate of 2.5%…”