Tax Evasion and Government Size—A Micro-Political Theory

Abstract

Previous studies on tax evasion and government size have not specified the “political_x000D_ mechanism” through which increasing difficulties with tax evasion might lead to government_x000D_ expansion. This paper attempts to fill in the gap. We extend the celebrated Meltzer and_x000D_ Richard (1981) model to a plausible world where tax evasion is possible. It is shown in this_x000D_ extended model that: (i) the decisive voter is still the individual who has a median pre-tax_x000D_ income, and (ii) the presence of tax evasion will lower the redistributive benefit of taxation_x000D_ and enhance the distortionary cost of taxation facing the decisive voter at the margin. As tax_x000D_ evasion becomes increasingly difficult with “modernization,” the marginal redistributive_x000D_ benefit of taxation will be enhanced and the marginal distortionary cost of taxation will be_x000D_ mitigated. This provides tax-evasion routes with a micro-political foundation to explain the_x000D_ expansion of government.