Tax Evasion in Firms

Abstract Tax evasion is low in many countries because third‐party reporting makes employees unable to cheat. Why do not employees collude with their employer to evade taxes or evade as self‐employed? We explain this puzzle in a model in which employees have both options. A trade‐off between large‐scale efficient production and tax evasion implies that tax evasion per employee is decreasing in firm size. The model predicts that there is a gap between the individually and the collectively optimal evasion in firms and that this gap is increasing in firm size. Using survey data, we find support for both predictions.