This paper reviews some central issues that arise in theorizing about tax evasiondecisions and the hidden economy. It starts from the Allingham-Sandmo (1972) modelling ofthe tax evasion decision as a choice under uncertainty based on expected utility maximizationand risk aversion. It goes on to discuss alternative specifications of the taxpayer’s preferenceswith particular regard to the explanation of the extensive margin, i.e. the decision on whetheror not to engage in tax evasion. It extends the model to the case of variable labour supply withwork in both official and black labour markets. It then considers the application of the theoryto taxes on wealth and income from capital, indirect tax evasion and smuggling. It alsoincludes a consideration of general equilibrium effects and of the problems that evasioncauses for the theory of optimal income and commodity taxes. It concludes with a briefdiscussion of the implications of tax evasion for economic policy in the welfare state.
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