Optimal income taxation without tax evasion

This paper incorporates corruption in the tax administration in a Mirrleesian model of optimal income taxation. In a multi-type setting with a discrete ability distribution, we show that the marginal tax structure can be designed to fully offset the incentives to evade taxes. The optimal marginal tax rates reflect two key determinants: the welfare weight the government attaches to each ability type, and how the private cost of tax evasion varies across the income distribution. We also extend the analysis by examining how public expenditures on tax enforcement can serve as a complementary instrument.