Thursday, September 20, 2012

Tax evasion as an automatic stabilizer

A short while back, a lot of attention was given to disparaging comments made by Christine Lagarde about tax evaders in Greece. I certainly agree that tax evasion is an issue in terms of fairness, as it shifts the burden of funding the government budget from evaders to those who honestly pay their taxes and might render government attempts to shift behavior into certain directions, by taxing them differently, ineffective.

However, as far as macroeconomic stabilization is concerned, I am surprised that there is not more people who proclaim the virtues of tax evasion during a recession. Let me consider how economist of different convictions might think about tax evasion:

 On the one hand, those old-style Keynesians still out there should think of tax evasion as a kind of automatic tax cut in bad times. Assuming that workers are more likely to try to avoid paying taxes when times are bad or that the unemployed will look for black market jobs, the avoidance of tax in a recession should increase the government deficit and thereby stimulate the economy. At the same time, the marginal propensity to consume out of undeclared income is probably greater than out of declared income, as black market transactions tend to be handled in cash instead of being initially deposited into a bank account.

Supply-siders on the other hand should see this a victory for the Laffer curve: Tax evasion serves as evidence that high taxes might in fact lead to lower tax revenue due to distorting human activities away from the purview of the tax collector. Similarly, tax evasion should be more likely to occur in those parts of the economy where taxes are most burdensome and therefore serve to alleviate part of the distortions introduced by the government.

Even the market-monetarist should find something to delight in it: as workers can receive part of their compensation untaxed, they should be willing to work for lower wages and thus the downward adjustment of sticky wages should be accelerated by the tax evasion. In effect, the social norm that taxes may be avoided in bad times delivers the employer payroll tax cut that Scott Sumner, for instance, has advocated, but without having to go through the slow process of the legislature.

All things considered, the debate about tax evasion should be a lot more lively than it is, with supporters holding their own against detractors. I don't know why that is not the case. Is mood affiliation with the coalition against the thing with the bad name "evasion" the reason?

This all assumes that medium-term government debt stabilization is more easily feasible once the crisis is over and that the central bank does not actively try to sabotage the recovery, but those things are a given, right? Right?

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