Capital Income Tax Evasion, Capital Accumulation and Welfare

We construct an overlapping-generations model where individuals evade capital income tax and carry out the short- and the long-run analyses to abstract the pure effects of policy parameters such as the capital income tax rate and the penalty rate on welfare levels. We show that: (i) undeclared savings may increase both in the short- and the long-run, even when the tax rate (the penalty rate) decreases (increases); (ii) there are trade-offs within each policy and across policies regarding the welfare effects in the short- and the long-run; (iii) both the welfare levels and the government rev enue increase in the long-run if the tax rate decreases or the penalty rate increases, as long as the elasticities of such parameters on capital stock are sufficiently large.