Income tax evasion and the fear of ruin

Abstract

This paper characterizes the optimal income tax function when the agent is risk averse and the objective of the principal is to maximize a social welfare function. We show that the optimal tax function is generally non-decreasing and concave if the principal's objective is maximin and the agent's utility function satisfies a reasonable condition which we call 'repetitive risk aversion'. It is shown further that in many cases the optimal tax function is similarly concave when the social welfare function is utilitarian. © The London School of Economics and Political Science 2006.