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The paper gives an overview of some main themes in the theory of tax evasion, starting from Allingham and Sandmo (1972). It reviews the comparative statics of the original model of individual behavior where the tax evasion decision is analogous to portfolio choice, and its extensions to incorporate socially conscious behavior, participation in the black labor market and tax evasion by firms. It also discusses the analysis of tax incidence and the problems involved in moving from individual to aggregate analysis, finally, it reviews the issues that arise in formulating models of optimal taxation in the presence of tax evasion.
INTRODUCTION
If someone were to write a full history of taxation, including both practitioners' experience and the thinking of theorists, it is probably a good guess that tax evasion would be part of the picture from the very start. The formal economic theory of tax evasion, on the other hand, is of considerably more recent origin and started to develop only a little over 30 years ago. To the best of my knowledge, its beginning can be dated to 1972(1) with the publication of the article "Income Tax Evasion: A Theoretical Analysis" by Michael Allingham and myself (Allingham and Sandmo, 1972).2 It was followed by a large number of contributions to the literature which extended the original model in a number of directions. The present paper, although not attempting a complete survey of the literature, reviews the main problems and developments in the theoretical literature on tax evasion and relates it to other issues that have traditionally been central in the theory of public finance.
Recent decades have also seen a number of attempts to provide empirical estimates of the size of the "hidden economy." Although little of the empirical research, at least to begin with, was based on an underlying theoretical structure, there is no doubt that the empirical work and the policy discussions that followed from it gave inspiration to further theoretical work, and that theory also gave new directions for empirical investigations. The literature through the 1980s was very nicely surveyed by Cowell (1990); more recent surveys include Andreoni, Erard and Feinstein (1998), Slemrod and Yitzhaki (2002) and Cowell (2002).
In the present paper, I wish to take my...