Self-employment income tax evasion and inequality

This paper provides novel evidence on income tax evasion by the self-employed, using a novel dataset that links a household consumption survey with tax administration records in Italy. We find that the share of unreported income among self-employed households is approximately one-third of total income, a magnitude comparable to that documented in countries with substantially lower aggregate evasion. We show that income tax evasion primarily originates among liberal professionals, who underreport their income by about twice as much as small businesses do. The results suggest that Italy’s high aggregate evasion rate is driven primarily by the composition of economic activity and evasion opportunities, rather than by uniformly higher individual propensities to evade or weaker tax morale. Our distributional analysis reveals that tax evasion substantially distorts vertical and horizontal equity, worsening both forms of equity and increasing inequality in the tax burden across households.