The excess burden of tax evasion—An experimental detection–concealment contest

Tax evasion may cause social welfare losses due to the incentives of taxpayers to invest in the concealment and of tax authorities to invest in the detection of tax evasion. Reducing the investment of both parties at the same time would then lead to a Pareto improvement. Given that concealment and detection costs are hardly measurable in reality, we show in a controlled laboratory experiment that the welfare losses from a concealment–detection contest depend positively on the prevailing tax rate, but not on the penalty which is imposed in case of detected tax evasion. Hence, policy makers who are concerned about socially inefficient concealment and enforcement costs should focus on tax rates rather than penalty rates.