Tax evasion and the optimum general income tax.

Summary The paper incorporates tax evasion into a non-linear income taxation problem. Labor supply is endogenous and individuals are risk averse. We consider a two-group model: high wage (productivity) individuals and low wage (productivity) individuals, and study the properties of optimal auditing and taxation policies. We show that high wage individuals are never audited and that their marginal tax rate is zero. Low-wage individuals are audited with a probability that is strictly less than one. Their marginal tax rate is either positive or zero, depending on the regime to which the solution belongs. An audited taxpayer who is found to be honest receives a tax reduction. However, the other results of the article do not change if we exclude the possibility of rewarding honest taxpayers.