TAX EVASION, MONOPOLY AND NONNEUTRAL PROFIT TAXES

It is known in the literature that tax evasion does not influence the monopolist's output decision, and hence, profit taxes are neutral, eve n in the presence of tax evasion. This result is based on the assumpti on that the audit probability and the penalty rate are fixed or depend on the understatement or overstatement of relevant economic indicator s. However, under alternative and perhaps more reasonable formulations of the audit probability, the neutrality of profit taxes may not be p reserved. In particular, if the audit probability or the penalty rate varies with some reports made by the monopolist (such as reported cost or reported revenue or output level), then profit taxes are no longer neutral.