Itemised Deductions: A Device to Reduce Tax Evasion

Direct incentives and punishments are the most common instruments to fight tax evasion. The theoretical literature disregarded indirect schemes, such as itemised deductions, in which an agent has an interest in that other agents declare their revenue. Itemised deductions provide an incentive for consumers to declare their purchases, and this forces sellers to do the same. I show that, for any level of taxation, it is possible to increase tax proceeds by choosing the proper level of itemised deduction; the cost for the government on the consumers’ side is more than compensated by the extra proceeds on the sellers’ side.