Itemised Deductions: A Device to Reduce Tax Evasion [WP]

Abstract

With direct incentives and sanctions being the most common instruments to fight tax evasion, the theoretical literature has tended to overlook indirect schemes, such as itemised deductions, in which one agent's behaviour a effects the likelihood that others will declare their revenue. Itemised deductions provide an incentive for consumers to declare their purchases. This induces a partial shift in the demand from the black market to the legal one, for consumers need a transaction receipt to enjoy the tax deduction. I show that it is possible to increase tax proceeds by choosing a suitable level of itemised deduction, and this, for any level of taxation. Indeed, the cost for the tax authority on the consumers' side is more than compensated for by the extra procedes generated on the sellers' side.