Tax Evasion, Investment Shocks, and the Consumption Puzzle: A DSGE Analysis with Financial Frictions

Abstract

Recent studies identify Marginal Efficiency of Investment (MEI) shocks as important drivers of the business cycle. However, Dynamic Stochastic General Equilibrium (DSGE) models struggle to explain macroeconomic comovements between consumption and the key real variables after a MEI shock. Moreover, engaging in tax evasion practices is often an answer to financial constraints, which have been recognized as important determinants of cyclical fluctuations as well. We use a medium-scale New Keynesian DSGE model, that combines tax evasion with financial frictions, to simulate a MEI shock. We show that entrepreneurial tax evasion can solve the comovement problem to a fair extent.JEL codes: E22, E26, E32, E44, H26

Noncompliant behaviors in general equilibrium: A survey

“…The empirical evidence not only identifies financial frictions as important determinants of NCBs (Bose et al, 2012;Beck et al, 2014) but also documents reverse causality, in which a large shadow economy limits financial development (Giombini et al, 2018). This fact has encouraged researchers to investigate the interaction between NCBs and financial imperfections over the business cycle (Colombo et al, 2019;Chiarini et al, 2020Chiarini et al, , 2022among others).…”

“…In fact, credit-constrained agents, by means of tax evasion, might accumulate internal funds as a substitute for external finance. Following this perspective, in a mediumscale new Keynesian model augmented with the financial accelerator à la Bernanke et al (1999), Chiarini et al (2020Chiarini et al ( , 2022 stress the self-financing interpretation of tax evasion that provides the entrepreneur (the agent with credit limits) with financial resources in addition to his or her own net worth and an alternative to bank loans to make investments. In this context, when a recessionary demand shock hits the economy, underground production declines because of its greater flexibility to disinvest, with nonnegligible effects on the business cycle.…”

“…In this context, when a recessionary demand shock hits the economy, underground production declines because of its greater flexibility to disinvest, with nonnegligible effects on the business cycle. 14 The novelty in Chiarini et al (2020Chiarini et al ( , 2022 is that tax evasion is linked to the behavior of a subject (the entrepreneur) acting as an intermediary between banks and firms rather than being specific to the behavior of firms or households, as in most of the works cited. Specifically, the entrepreneur is the agent who produces capital services on behalf of households.…”

Legal Uncertainty in Taxation and Its Impacts on Labour Supply in the Czech Republic

“…Hayashida et al (2017) věnují pozornost dopadům šokům ve zdanění spotřeby a ukazují dopad jeho zvýšení na růst cenové hladiny a mezd a pokles spotřeby a úrokových sazeb. Možnosti existence stínové ekonomiky a roli investičních šoků řeší ve své práci Chiarini et al (2016). Orsi et al (2014) pak explicitně s využitím DSGE přístupu odhadují dynamiku stínové ekonomiky v Itálii a simulují dopady alternativních nastavení daňových sazeb a míry represe na její velikost.…”

The case for independence: Does central bank independence curb the spread of the underground economy?

“…2 See also Brumm (2000), Jácome and Vázquez (2008), Bowdler (2009), Klomp and De Haan (2009, 2010a, 2010b, Belke and Potrafke (2012), Posso and Tawadros (2013), Masciandaro and Volpicella (2016), Gelos and Ustyugova (2017), and Garriga and Rodriguez (2020). 3 In fact, several papers show that incorporating the underground economy in a dynamic general equilibrium model better fits the macroeconomic data (see, e.g., Chiarini et al, 2020;Ihrig & Moe, 2004). Using a similar approach, Gomis-Porqueras et al (2014), estimate the size of the shadow economy and show the relationship between the shadow economy and the inflation rate, and distortionary taxes.…”