A Markov-based decision model of tax evasion for risk-averse firms in Greece

We develop a Markov-based optimization model that captures the process via which a risk-averse firm in Greece decides whether to engage in tax evasion. The firm seeks to maximize the expected utility of its wealth, the latter viewed as a function of the portion of profits which the firm attempts to conceal from the government. Our model takes into account the basic features of the Greek tax system, including random audits and tax penalties applied when the audit reveals any wrongdoing. The proposed model is used to (1) show that the parameters currently in place are conducive to tax evasion and (2) “chart” the problem’s parameter space in order to identify “virtuous” combinations (from the point of view of the government), and obtain a relationship between audit probability, tax penalty and likelihood of the firm engaging in tax evasion.