Does Tax Evasion Affect Occupational Choice?*
| Published date | 01 July 2003 |
| DOI | http://doi.org/10.1111/1468-0084.t01-1-00050 |
| Date | 01 July 2003 |
| Author | Simon C. Parker |
Does Tax Evasion Affect Occupational
Choice?*
Simon C. Parker
School of Economics, Finance & Business, University of Durham, Durham, UK
(e-mail: s.c.parker@durham.ac.uk)
Abstract
This paper presents a novel micro-econometric procedure that identifies the
extent to which occupational choices are distorted by opportunities for tax
evasion. Previous studies claim to have found significant and substantial
effects, but analysis and replication of their methods reveals that they
generate conflicting and misleading results. The paper then implements the
new procedure using several British micro-data sets. A thorough empirical
investigation reveals that occupational choice between self-employment
and paid employment is not robustly related to pecuniary factors in
general, and is invariant to tax avoidance and evasion opportunities in
particular.
I. Introduction
Tax evasion affects the functioning of modern economies in several ways.
These are thought to include the revenues that governments can raise and
spend, the amounts of labour that workers supply, and the occupational
choices workers make if some occupations offer greater scope for income
concealment than others (Cowell, 1990). This paper focuses on the last of
these topics. It presents and implements a novel micro-econometric procedure
that identifies the extent to which occupational choices are distorted by
opportunities for tax evasion.
*The author would like to thank Martin Robson, Colin Wren and an anonymous referee for helpful
comments on an earlier draft, and the ESRC Data Archive for providing the BHPS and FES micro-
data. Material from these surveys made available by the ONS through the ESRC Data Archive has
been used by permission of the Controller of the Stationery Office. The usual disclaimer applies.
OXFORD BULLETIN OF ECONOMICS AND STATISTICS, 65, 3 (2003) 0305-9049
379
Blackwell Publishing Ltd, 2003. Published by Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK
and 350 Main Street, Malden, MA 02148, USA.
Governments need to know how individuals allocate their labour effort
between occupations as well as within them. They need this information to
design income taxation and counter-evasion policies, and to facilitate the
efficient deployment of workers. The ability of workers to adjust their work
effort between occupations in response to tax evasion incentives has been
recognized by Watson (1985), Kesselman (1989), Pestieau & Possen (1991)
and Jung, Snow & Trandel (1994). These authors analysed the effects of tax
evasion and optimal government policy when workers can switch freely
between two occupations. Reflecting the discretion that self-employed
workers have in declaring their incomes to the tax authorities, and the
relative lack of discretion by employees who are subject to a withholding tax
and third party reporting, these occupations are usually taken to be paid
employment and self-employment – a convention also adopted in this paper.
1
The above authors clearly demonstrated the potential importance of endo-
genous occupational choice for the design of corrective government tax
evasion policy.
It is, therefore, desirable to estimate the extent to which occupational
choice is affected by what is termed in this paper the ‘tax incentive’ to
being self-employed. Several previous studies have attempted to do this,
and claim to have detected significant and substantial tax incentive effects.
However, as explained and illustrated with sample data in section II, the
results obtained suffer from problems of interpretability and robustness,
deriving from their use of inappropriate proxy measures of the tax
incentive. The main contribution of this paper is to propose a new micro-
econometric estimation procedure in which the tax incentive effect is
measured appropriately. The new procedure is outlined in section III. It is
based on a four-stage structural probit model that conditions occupational
choice on after-tax relative incomes. Allowing for tax avoidance or evasion
yields a regression specification within which the tax incentive hypothesis
can be tested directly. The empirical results appear in section IV. The
results are striking. No evidence of a tax incentive effect is detected, a
result that is robust to a comprehensive sensitivity analysis. It cannot even
be clearly established that the self-employed respond to pecuniary
incentives generally, let alone tax-related ones specifically (see also
Aronson, 1991; Hamilton, 2000, who have adumbrated this point). The
policy implications of these results and other conclusions are drawn in
section V.
1
For work that explores income taxation with free choice between these two occupations, see
Kanbur (1979, 1981), Kihlstrom & Laffont (1982, 1983), Boadway, Marchand & Pestieau (1991),
Pestieau & Possen (1992), Black & de Meza (1997), Moresi (1998), Parker (1999, 2001), and Gentry
& Hubbard (2000).
380 Bulletin
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