We study the optimal mix of direct and indirect taxes in the presence of tax avoidance. It is shown that a linear consumption tax is part of the optimal tax scheme, and so even when the assumptions of the Atkinson-Stiglitz theorem are not satisfied. The reason is that taxing consumption is a way to tax true income, whereas income taxation only falls on reported income. We also show that, with a weakly separable utility function and linear Engel curves, tax rates should be uniform across goods. With nonlinear Engel curves, which good should be taxed more depends on the comparison of a redistributive and an efficiency effects.
Available at: http://works.bepress.com/georges_casamatta/19/