This paper incorporates tax evasion into a one-sector real business cycle model, and income taxation is endogenously determined in order to balance the government budget (such as Schmitt-Grohè and Uribe, 1997). We find that an economy with tax evasion can make the macroeconomy become more stable, and a higher fraction of labor income tax evasion has a stronger stabilizing effect. Moreover, a government that has tax evasion prevention policies could reduce the fraction of tax evasion, but equilibrium indeterminacy is more likely to occur. Accordingly, the government’s policy to cut down on labor income tax evasion has a destabilizing effect.
