Tax Evasion, Concealment and the Optimal Linear Income Tax

This paper incorporates tax evasion into the analysis of optimal linear income taxation. Taxevaders can influence the probability of being caught, if audited, through expenditures on concealment. It is proved that tax evasion can make a given tax system more as well as less progressive depending on the concealment technology. The paper derives and interprets simple formulas for characterizing the optimal tax rate and audit probability. It also gives sufficient conditions under which tax evasion lowers the optimal tax rate, while showing that an increase in the optimal tax rate is also possible.