Tax Evasion and Government Size— A Micro-Political Theory

Previous studies on tax evasion and government size have not specified the "political mechanism" through which increasing difficulties with tax evasion might lead to government expansion. This paper attempts to fill in the gap. We extend the celebrated Meltzer and Richard (1981) model to a plausible world where tax evasion is possible. It is shown in this extended model that: (i) the decisive voter is still the individual who has a median pre-tax income, and (ii) the presence of tax evasion will lower the redistributive benefit of taxation and enhance the distortionary cost of taxation facing the decisive voter at the margin. As tax evasion becomes increasingly difficult with "modernization," the marginal redistributive benefit of taxation will be enhanced and the marginal distortionary cost of taxation will be mitigated. This provides tax-evasion routes with a micro-political foundation to explain the expansion of government.