We consider a model in which agents have the possibility of hiding some of their earnings in order to avoid taxation. Taxes only finance a pension system, which includes a contributory and a universal component. Without non-compliance costs, agents are indifferent to the tax rate as in response they can adjust their level of compliance; the pension system must be at least partially contributory in order to increase tax compliance and, thus, the tax base. With non-compliance costs, the majority-voted tax rate is more likely to be high when the median income is low and when the return from public pensions dominates that of private savings. The size of the contributory component will now result from a trade-off between increased political support, direct redistribution toward the worst-off agent, and a larger tax base.
Compliance, Informality and contributive pensions