Austerity Plans and Tax Evasion : Theory and Evidence from Greece.

The unprecedented tax hikes implemented in Greece in 2010 generated a much lower than expected increase in tax revenues. In this paper, we document a new stylized fact explaining this gap: the strong increase of tax evasion. We then analyze the response of the economy to tax hikes in a stylized model where firms adjust the share of their declared activity. We calibrate the model to firm-level balance sheet data for Greece and quantify the response of tax evasion to the 2010 fiscal adjustment. One third of the tax increase is lost because small and medium size firms expand their share of non-declared activity. In turn, this lowers their borrowing capacity and contributes to non-negligible output losses.