Controlling Tax Evasion Under Direct and Indirect Taxation: Some Notes

Working Papers 66 Koskela Erkki

The purpose of the paper is to use a simple model of the firm having monopoly power in the goods market as the framework to study the relative effectiveness of ulnit, ad valorem and profit taxes under two alternative criteria when the taxes are changed so as keep either the expected utility of the monopoly firm or the expected tax revenues for government constant. Under the former policy the profit tax turns out to be best and the unit tax worst in all respects; for instance , the profit tax will give rise to higher production, lower prices, lower tax evasion and higher tax revenues for government than other taxes. The dominance of the profit tax and the interiority of the unit tax still holds under the policy of keeping the expected tax revenues constant in terms of production, prices and the expected utility of the monopoly firm. But strikingly, in terms of effectiveness of tax evasion control the ranking of taxes is now exactly the reverse from the one obtained under the expected utility criterium; now the unit tax is best and the profit tax worst