Firms are subject to many forms of government regulation and laws. Two major sources of these regulations are corporate tax laws and labour or employment laws. For example, labour codes stipulate that firms must ensure their workplaces meet certain safety and health standards, and pay payroll taxes to cover the provision of government provided benefits to their workers, whereas corporate tax laws require firms to collect sales taxes on goods sold and pay taxes on their income or profits. There are many ways for firms to evade these legal requirements. Much of the literature examining the evasion behaviour of firms assumes that the decision to evade one form of regulation (such as labour regulation) is perfectly linked to the decision to evade another (such as paying business corporate taxes). In this paper, we separate these two evasion decisions and allow firms to decide whether to evade labour market regulations (including the payment of payroll taxes) independently from their decisions to evade corporate taxes. We characterize the firms’ optimal entry and evasion behaviour and derive the government's optimal tax policies.
