Institutions, Corruption and Tax Evasion in the Unofficial Economy

Douglas A. Hibbs () and Violeta Piculescu
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Violeta Piculescu: Göteborg University

Public Economics from EconWPA

Abstract: In this paper we propose a model of how institutional benefits, taxation and government regulations affect the productive activity of private enterprises. We consider an environment in which public officials enforcing tax and regulatory obligations are potentially corruptible, and markets for corruption may therefore arise that give firms the option of producing unofficially and evading taxes and regulations. By contrast to some previous studies that view corruption and bribery as forces driving firms out of official production into the underground economy, our model features the idea that the `grabbing hands' of corrupt bureaucrats may alternatively serve as `helping hands' allowing firms to exploit profitable opportunities in the unofficial sector. And contrary to a traditional view maintaining that high tax rates are intrinsically a major cause of large shadow economies, our model implies that incentives to evade taxation and produce underground depend on statutory tax rates relative to firm-specific thresholds of tax toleration. Tax toleration is determined, among other things, by firm-specific institutional benefits available to official producers and the costs of corruption required to produce unofficially. Some core predictions of the model concerning the determinants of tax toleration and the relative size of unofficial activity and tax evasion receive broad support from empirical analyses based on firm-level data from the World Business Environment Surveys sponsored by the World Bank.

Keywords: institutions; corruption; tax; evasion; unofficial; economy; underground; economy (search for similar items in EconPapers)
JEL-codes: D21 H26 K42 O17 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-acc, nep-dev, nep-law and nep-reg
Date: 2005-08-05
Note: Type of Document - pdf; pages: 30
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwppe:0508003

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