Bribes and Business Tax Evasion

TL;DR: Chen et al. as discussed by the authors explored how bribes to tax officials shape business tax evasion in transition economies and found that tax evasion is much higher when firms perceive bribery to be widespread than when they are believed never to take place.

Abstract: 1. Introduction Business tax compliance is critical to the fiscal viability of governments. This is particularly true because the bulk of the government's tax revenues, including taxes on profits, VAT and sales taxes, income tax withholding, and employment taxes are collected or paid by business (Joulfaian, 2000). Yet despite its importance, little is known about business tax compliance and the behavioral consequences of the various tax regimes (Cowell 2004). Indeed, the empirical literature on business tax evasion is scant, in sharp contrast to the voluminous work on individual income tax compliance (Clotfelter 1983; Cowell, 1990; Slemrod, 1992). Tax administration, in particular as it relates to the penalty and detection regimes, figures prominently in determining the level and character of tax evasion (Allingham and Sandmo, 1972). Yet governance may compromise the efficacy of such tax regimes. For example, some of the transition economies of Europe and the former Soviet Union may be characterized as regimes with stiff if not draconian penalties for engaging in tax evasion. But these states are also plagued with serious governance shortcomings, with tax penalties that apply at the discretion of tax officials. (3) This raises the question of whether corruption, and in particular bribes to tax officials, reduces tax compliance as it compromises the statutory detection and penalty regimes. This paper explores how bribes to tax officials shape business tax evasion in transition economies. The results suggest that governance, particularly as it relates to tax administration, is an important determinant of business tax compliance behavior. Basic sample statistics show that noncompliance is much higher when firms perceive bribes to be widespread than when they are believed never to take place. This is further confirmed using multivariate analysis which shows tax evasion to increase with the frequency of tax related bribes. In addition, the findings suggest that the estimated effects of bribes are likely to be larger when their potential endogeneity is controlled for. The analysis controls for the form of organizational choice and nature of the largest shareholder. It also accounts for the effects of tax rates, firm size, industrial classification, and country effects. The remainder of the paper is organized as follows. Section 2 presents a brief review of the literature on business tax evasion. Section 3 presents a simple theoretical framework to motivate the empirical modeling of business evasion, and provides a description of the data on 27 economies. These countries cover central and eastern Europe, and the former Soviet Union. Empirical results are reported in Section 4, which also explores the endogeneity of bribes to evasion. Concluding comments are provided in section 5. 2. Literature Review A large body of the literature has addressed the determinants of personal income tax evasion since the seminal work of Allingham and Sandmo (1972). However, and in contrast to the numerous studies of personal income tax evasion, only a few studies have addressed business tax evasion. Some of the theoretical aspects of business tax evasion have been addressed. Marrelli (1984), for instance, compares tax evasion under a value-added tax to that under a profit tax, and finds that evasion patterns depend on risk aversion assumptions. Marrelli and Martina (1988) analyze tax evasion in the context of an oligopolistic market, while Kreutzer and Lee (1986 and 1988) and Wang and Conant (1988) analyze the effects of opportunities to evade taxes on the optimal output of a monopolist. Cremer and Gahvari (1993) and Virmani (1989) focus on competitive industry. Cowell (2004) provides an extensive review of this literature. Expanding on the scope of studies on business tax evasion, Chen and Chu (2005) focus on the separation of ownership and control, and how this results in efficiency loss. …