Tax Evasion, Corruption and Market Entry
| Published date | 01 September 2016 |
| Date | 01 September 2016 |
| DOI | http://doi.org/10.1111/sjpe.12100 |
| Author | André Seidel,Marcel Thum |
TAX EVASION, CORRUPTION AND
MARKET ENTRY
Andr
e Seidel* and Marcel Thum**
ABSTRACT
We analyze the impact of tax policy on the market entry of firms in the presence
of corruption and tax evasion. In a world with corruption, firms must bribe cor-
rupt officials to enter the market. For a given level of bribes, higher tax rates
and stricter enforcement of taxation decrease tax evasion but typically reduce
market entry. However, when the level of bribes reacts to tax policy, higher
taxes and stricter enforcement of taxation can have a double benefit. Up to a
certain threshold, for which we develop a simple rule, stricter enforcement
increases market entry and reduces tax evasion.
II
NTRODUCTION
The distortion of resource allocation by corrupt officials and the insufficient
provision of public goods due to low tax revenue are often mentioned as
important impediments to economic growth, particularly in developing coun-
tries. The fight against corruption and tax evasion is high on the agenda of
many development agencies.
1
In the economic literature, both phenomena are
discussed extensively, but they are rarely combined within a unifying frame-
work. We argue that both phenomena must be considered simultaneously. In
this article, we analyze the impact of tax policy on the market entry of firms
and on tax revenue in the presence of corruption and tax evasion.
There are two almost completely separate strands of literature on tax evasion
and corruption.
2
In the literature on corruption, a number of papers have ana-
lyzed, for instance, the impact of bribes on the market entry of firms. This litera-
ture stresses that corruption is detrimental to welfare because it acts as an entry
barrier for productive firms. Empirically, the causal effects of corruption on
market entry are difficult to identify, as data on potential entrepreneurs who do
not enter a market are nonexistent almost by definition. Nevertheless, there is
*TU Dresden
**TU Dresden, ifo Dresden and CESifo
1
See, for example, ‘United Nations Convention against Corruption’; ‘OECD Anti-Bribery
Convention’; ‘OECD Forum on Tax Administration (FTA)’ or ‘World Bank Tax Adminis-
tration Reform Projects’.
2
See Slemrod (2007) for a survey of the literature on the economics of tax evasion and
Aidt (2003) for a survey of the literature on the economics of corruption.
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12100, Vol. 63, No. 4, September 2016
©2015 Scottish Economic Society.
377
abundant empirical evidence that corruption obstructs entrepreneurial activity
and economic development. For example, using firm level data from Uganda,
Fisman and Svensson (2007) provide ‘some validation of firm-level theories of
corruption, which posit that corruption retards development’.
3
Typically, taxes
and tax evasion play no role in models of the industrial organization of corrup-
tion. In contrast, the literature on tax evasion, which dates back to the seminal
paper by Allingham and Sandmo (1972), mostly focuses on the determinants of
and remedies for tax fraud. Part of this literature also explicitly deals with wel-
fare effects due to market entry or exit. For instance, Goerke and Runkel (2011)
show that competition policy that reduces entry costs may also trigger higher
tax evasion. Corruption that inhibits market entry, however, is not considered
in this literature.
We want to bridge this gap in the literature. In particular, we examine
whether there is a trade-off between tax revenue and market entry when firms
can evade taxes and when they face corruption. We use a simple model of
firm behavior as a starting point. Firms face two decisions. Each firm must
decide whether to enter the market and what the extent of its tax evasion will
be. Firms are heterogeneous in their productivity, and they enter the market if
they can generate nonnegative profits. We incorporate corruption by assuming
that firms must pay a bribe to a corrupt official to obtain a license for market
entry. This type of bribery is frequently studied in the literature on the indus-
trial organization of corruption. For instance, Shleifer and Vishny (1993) ana-
lyze the consequences of corruption on market entry in such a framework and
show that decentralization of bureaucratic organizations can even lead to infe-
rior outcomes. Another important aspect concerns the interaction between
corruption and competition (Bliss and Di Tella, 1997; Emerson, 2006). The
framework has also been used to obtain a better understanding of policy mea-
sures such as job rotation in corrupt environments (Choi and Thum, 2003) or
to explain patterns of arbitrariness in bribe demands (Choi and Thum, 2004).
These bribe payments for market access clearly differ from bribes paid to cor-
rupt officials in the tax administration, which are paid by firms that are
already active in the market and that want to reduce their tax burden. With
such bribes, the corrupt tax official and firm collude at the expense of the gov-
ernment’s tax revenue. The literature on corruption in the tax administration
is small but growing (Chander and Wilde, 1992; Besley and McLaren, 1993;
Flatters and Macleod, 1995; Hindriks et al., 1999; M
endez, 2012). Studies in
this stream of literature analyze the role of monitoring, incentives and punish-
ment in efforts to fight the collusive behavior between corrupt officials in the
tax administration and tax-evading firms. Welfare effects due to market entry
or exit play no role in this literature, almost by definition, as firms dealing
3
Most studies focus on the impact of corruption on growth. The seminal paper is Mauro
(1995). A recent meta-analysis is provided by Campos et al. (2010) who analyze 460 esti-
mates from 41 studies and confirm a negative corruption–growth nexus. However, corrupt
bureaucrats may also foster economic activity, when entry is already distorted by excessive
regulation. The ‘greasing the wheels’ hypothesis is confirmed, e.g. for imports in high-tariff
countries by de Jong and Bogmans (2011) and for entrepreneurship in countries with high
entry barriers by Dreher and Gassebner (2013).
378 ANDR
E SEIDEL AND MARCEL THUM
Scottish Journal of Political Economy
©2015 Scottish Economic Society
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