Black Markets and Optimal Evadable Taxation

John McLaren
A simple model of indirect taxation, evasion, and enforcement is presented in which some surprising results emerge. Because of a "˜market-thinning' effect of high prices, high taxes lead to multiple equilibria (low-price black markets and high-price legal markets), and black-market comparative statics tend to give the "˜wrong' sign. Further, the incentive compatibility constraint for tax compliance is shown to confer a kind of concavity on enforcement costs. As a result, enforcement costs may be minimized...
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