To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.1111/j.1475-4932.2010.00654.x Byline: RATBEK DZHUMASHEV (1), EMIN GAHRAMANOV (2) Keywords: H26; D91; O41 Abstract: We develop an endogenous growth model a la Barro (1990), augmented with income tax evasion. Unlike many traditional rational choice models of tax evasion, the numerical simulations of our model do not produce counter-intuitive results. Further, we show that: (i) accounting for evasion costs (while capturing the full risk associated with the tax evasion process) is important for obtaining realistic relationships between key model variables; (ii) productive government expenditures explicitly affect the economy's tax evasion rate; (iii) Barro's natural efficiency condition for setting the optimal statutory tax rate holds even in the presence of tax evasion; (iv) given realistic estimates of the public expenditure externality, the average marginal income tax rate in Australia is not too far away from the optimal one; and (v) differences in tax evasion opportunities aggravate inequality over time. Author Affiliation: (1)Department of Economics, Monash University, Berwick, Victoria, Australia (2)School of Accounting, Economics and Finance, Deakin University, Burwood, Victoria, Australia Article note: Emin Gahramanov, School of Accounting, Economics and Finance, Deakin University Burwood campus, 70 Elgar Road, Melbourne, VIC 3125, Australia. Email: eming@deakin.edu.au