The paper formalizes the relation between flat taxes and growth when there is a competitive equilibrium tax evasion. A decentralized tax evasion service is supplied by the banking sector. The bank production function follows the financial intermediation microfoundation approach, with deposits as an input. Across a class of endogenous growth models, tax evasion decreases the effective tax rate, and thereby lessens the negative effect of taxes on growth. And as the tax rate rises, tax evasion causes the growth rate to fall by less. Underlying the results is a fiscal principle whereby tax evasion creates, or magnifies, a rising demand price sensitivity to higher tax rates.
Tax evasion financial intermediation endogenous growth and flat taxes