Contributive Pensions and Imperfect Tax Compliance: A Political Economy Model

28 Pages Posted: 21 Jan 2016

See all articles by M.‐L. Leroux

M.‐L. Leroux

University of Quebec at Montreal (UQAM)

Dario Maldonado

Universidad del Rosario - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Pierre Pestieau

University of Liège - Research Center on Public and Population Economics; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Catholic University of Louvain (UCL) - Center for Operations Research and Econometrics (CORE)

Date Written: June 2018

Abstract

This paper sheds light on the role of public institutions as a way to reduce tax evasion through a close link between payroll taxation and pension benefits. We use a political economy model in which agents have the possibility to hide part of their earnings in order to avoid taxation. Taxation is exclusively used to finance a pension benefit which is partly redistributive. We show that in the absence of evasion costs, agents are indifferent to the tax rate level as they can always perfectly adapt compliance so as to face their preferred effective tax rate. There is unanimity in favour of the maximum tax rate and, the public pension system is found to be contributory in order to increase compliance and thus the resources collected, which in turn enable higher redistribution toward the worst-off agents. When evasion costs are introduced, perfect substitutability between compliance and taxation breaks down. The majority voting equilibrium is such that individuals at the bottom of the income distribution who are in favour of more redistribution, and those at the top who want to transfer more resources to the old age, form a coalition against middle-income agents, in favour of high tax rates. In addition to the tax base argument, the optimal level of the Bismarkian pillar will now be chosen so as to account for increased political support.

Keywords: evasion costs, majority voting, public pensions, tax compliance

JEL Classification: H550, D780, D910

Suggested Citation

Leroux, Marie-Louise and Maldonado, Dario and Pestieau, Pierre, Contributive Pensions and Imperfect Tax Compliance: A Political Economy Model (June 2018). CESifo Working Paper Series No. 5656, Available at SSRN: https://ssrn.com/abstract=2719461 or http://dx.doi.org/10.2139/ssrn.2719461

Marie-Louise Leroux (Contact Author)

University of Quebec at Montreal (UQAM) ( email )

PB 8888 Station DownTown
Succursale Centre Ville
Montreal, Quebec H3C3P8
Canada

Dario Maldonado

Universidad del Rosario - Department of Economics ( email )

Casa Pedro Fermín
Calle 14 # 4-69
Bogota
Colombia

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Pierre Pestieau

University of Liège - Research Center on Public and Population Economics ( email )

Boulevard du Rectorat, 7, Batiment 31
Sart-Tilman
B-4000 Liege, 4000
Belgium
+32 4 366 3108 (Phone)
+32 4 366 3106 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Catholic University of Louvain (UCL) - Center for Operations Research and Econometrics (CORE) ( email )

34 Vopie Roman Pays
Louvain la Neuve
Belgium

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