Abstract

Purpose – The purpose of this paper is to show a standard RBC model, when augmented with a VAT
evasion channel, where evasion depends on the consumption tax rate, can produce a hump-shaped
consumption-Laffer curve.
Design/methodology/approach – The methodology is in the spirit of modern quantitative macroeconomic
literature.
Findings – The model with VAT evasion can generate a peaking consumption tax revenue curve, which is a
little discussed result in the taxation literature.
Research limitations/implications – The paper contributes to the public finance literature by providing
evidence for the importance of the evasion mechanism, while at the same time adding to the debate about the
existence of a peak tax rate for consumption tax revenue.
Practical implications – Contrary to popular belief, raising VAT rate as a cheap way (being a tax on
demand) to finance government expenditure, is still not a free lunch, and raising the rate, especially in a
country with substantial VAT evasion, quickly leads to a drop in the revenue associated with that category.
Originality/value – This is the first study that provides a tractable model of VAT evasion, and a setup
where consumption tax revenue curve is peaking.