Reducing the wage wedge
In this years' EALE conference, we presented our research paper on optimal tax policy in the presence of tax evasion. Unlike many of the models from the literature, we embrace the idea that firms might misbehave, in this case via avoiding taxes, and try to understand how this affects possible policies. In our model, firms can hire identical workers in two markets: a primary market, where social security contributions are paid, and a secondary market, where workers are hired without this provision. On the one side, firms save funds by not paying social security contribution, however, if caught, they need to pay a surcharge. On the other hand, and because workers prefer to work in the primary sector, they would ask for a monetary compensation for working without social securities.
Our model, calibrated to the EU, shows several interesting results. First, we recover a Laffer curve, that is at some point a further increase in taxes can reduce tax revenue. However, our Laffer curve is located below that of the standard literature and peaks earlier. These are logical consequences of the possibility to avoid taxes. Second, we conduct policy experiments. In particular, whether on top of an optimal tax rate there is an optimal tax composition. We do so by modifying the share of avoidable taxes (social security contributions) for a given tax rate. In our model, it is optimal to increase the tax rate, and also raise the share of avoidable tax to the levels of the French economy. By doing so, the government can raise total tax revenue and welfare of the society. Our French audience was happy to hear about this :)