Summary: This analysis expands the model of tax evasion suggested by M. G. Allingham and A. Sandmo [J. Publ. Econ. 1, 323–338 (1972)] to include public goods, financed by revenues from taxation and penalties. We argue that this leads to a Pareto inferior equilibrium outcome of individual declarations both in models of competitive and interdependent behaviour, thus linking the paradox to the Prisoner’s Dilemma, well known from game theory. It is further claimed that a government led by utilitarian welfare standards will perpetuate tax evasion in the case of positive variable costs of detection.