The Macroeconomic Implications of Fiscal Policy with Tax Evasion

This paper studies equilibrium effect of fiscal policy disturbances within a dynamic general equilibrium model where tax evasion and underground activities are explicitly incorporated. There are three main results. (i) The underground sector mitigates the distortionary impact of fiscal policies, while lessening the drop (and the rise) of aggregate production after restrictive (expansionary) tax shocks. (ii) Tax evasion and underground economy can be seen as an economic mechanism that rationalizes the arise of non-keynesian effects in response to fiscal policy shocks. (iii) A dynamic general equilibrium with tax evasion gives a rational justification for a Laffer curve.