Optimal tax enforcement and the income tax rate: the role of taxable income inequality

This paper considers the problem of jointly determining the optimal income tax rate and the optimal degree of enforcement by the authorities. It extends the analysis of Keen and Slemrod, who combine the well-known elasticity of taxable income with an enforcement elasticity of taxable income. The model is extended to the many-person context with both differing wages and preferences, and with a tax and transfer system along with the desire for redistribution on the part of the government. The effect of inequality, defined in terms of an equally-distributed-equivalent taxable income measure, is explored. There is also government expenditure on a pure public good. The model is also extended to allow for a direct effect on labour supply of tax enforcement, and the implications for the optimal enforcement gap.