Template-Type: ReDIF-Paper 1.0
Author-Name:  Sebastian Castillo
Author-Name-First: Sebastian
Author-Name-Last: Castillo
Author-Email: sebastian.castillo@helsinki.fi
Author-Workplace-Name: University o fHelsinki, Helsinki GSE and the Finnish Centre of Excellence in Tax Systems Research
Title: Tax Policy Design in a Hierarchical Model with Occupational Decisions
Abstract: This study incorporates occupational decisions in a hierarchical model to investigate distortions
in the tax policy design. The economy has two sectors, wage-earners and self-employment, where
evasion is only possible in the latter. The optimal audit split self-employed between audited and
non-audited distorted the occupational decision in the last group. The marginal tax rate is
smaller than the case without occupational choices, showing that not considering it produces an
upward tax bias. The optimal IRS budget does not allow for auditing the entire self-employment
sector but is larger than the case without occupational choices. Production efficiency is not
attained at the optimum because occupational decisions are distorted. This result contradicts
the Diamond-Mirrlees theorem. Finally, differential taxation is a Pareto improvement but implies
higher taxes for self-employment. This result increases distortions in the optimal allocation of
agents compared to the former setting.
Length: 44 pages
Creation-Date:  2022-11
Publication-Status: Published in FIT Working Paper Series, Finnish Center of Excellence in Tax Systems Research
File-URL: https://verotutkimus.fi/verotutkimus/wp-content/uploads/2022/11/FIT-WP2-Tax-policy-design-Castillo-3.pdf
File-Format: Application/pdf
File-Function: First version, 2022
Number: 2
Classification-JEL: H26, H21, H83
Keywords: Tax Evasion, Hierarchical Model, Tax Policy, Auditing, Income Taxation, Occupational Choice, Production efficiency
Handle: RePEc:fit:wpaper:2