Tax Evasion, Firm Dynamics and Growth

Emmanuele Bobbio
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Emmanuele Bobbio: Bank of Italy

No 683, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: Italy's growth performance has been lacklustre in the last two decades. The economy has low R&D intensity; firms are smaller and less likely to grow or exit than firms in other advanced countries; the shadow economy is large. I show how these features arise simultaneously in a Schumpeterian growth model with heterogeneous firms where the tax auditing probability increases with firm size. Tax evasion confers a cost advantage over competitors. In equilibrium, small firms invest less in innovation because growing entails a (shadow) cost of fiscal regularization. Unfair competition forces other firms to lower the mark-up they charge for their new products, reducing the incentive to innovate. Market selection is hampered, further lowering the aggregate growth rate along the extensive margin. I calibrate the model on Italian firm-level data for the period 1995-2006 and find that enforcing taxes would have increased the long-run growth rate from 0.9% to 1.1%. The market share of high type firms would have been 8 percentage points higher and average firm size 25% higher. Also, I find that lowering the tax burden can have a significant impact on growth when the shadow economy is large, while the effect is negligible when taxes are enforced.

Date: 2017
New Economics Papers: this item is included in nep-bec, nep-dge, nep-ent, nep-iue, nep-pbe, nep-sbm and nep-tid
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