Public Trust, Taxes and the Informal Sector

37344

Several studies surprisingly associate higher taxes with smaller informal economy. To account for this phenomenon we build a simple model of optimal taxation and argue that this can be explained by differences in public trust in governments. In equilibrium, if producers’ trust in the government is lower (higher), the government announces a lower (higher) tax rate on the formal sector, but more (fewer) producers chose to stay in the informal economy. Finally, using panel data estimation techniques we provide empirical support for our theory.

27

informal sector , tax evasion , public trust , subgame , perfect equilibrium.

Bogazici Journal

44

Bogazici Journal