ABSTRACT
The chapter develops an economic model of optimal auditing when taxpayers can choose both to evade and avoid tax. The model predicts that it is often more difficult – that is, more expensive to the tax authority – to induce compliance of wealthier taxpayers. Also, when the penalty increases at a steeper rate with evasion, a lower reported income indicates that the taxpayer’s preferred mix of avoidance and evasion is likely to have moved in favour of avoidance, because the competitiveness of the market for avoidance schemes increases, and the social stigma associated with tax non-compliance falls.
