Size-Dependent Enforcement, Tax Evasion and Dimensional Trap

Size-dependent tax enforcement is quite widespread worldwide, but the literature on its effects over firms' behaviour is very scarce. By assuming different audit probabilities for small and large firms, we propose a dynamic model to study the consequences of size-dependent monitoring level on a firm' fiscal compliance and its decision to invest and grow in a single-firm perspective. By combining analytical findings and simulation results, we show that: (1) under certain conditions, a dimensional trap may emerge, as small firms have no advantage in growing and prefer to remain small to avoid stronger enforcement; (2) audit activity and fine levels are important tools available to the State to fight evasion, but a careful calibration is required not to incur undesired effects.