Corruption as an Occupational Choice: Endogenous Corruption and Tax Policy

Abstract

Corruption is endemic in many countries, and empirical studies have demonstrated how it impacts on macroeconomic indicators. Theoretical studies have generally assumed an exogenously given proportion of the population are corrupt or that the public sector is fixed in size; far fewer explore how corruption emerges endogenously. We endogenize corruption as an occupational choice. Workers choose private or public employment; public employees can be honest or corrupt. Corruption is subject to a social sanction that results in a loss of self‐esteem. Those who care little about the social sanction choose to be corrupt. When a firm meets a corrupt public employee it pays a bribe to secure a reduction in the tax rate. The economy has two self‐sustaining equilibria with different levels of corruption. Corruption reduces tax revenue and the tax rate that maximizes revenue. An increase in the social sanction reduces corruption but also reduces tax revenues if the economy is in a high‐corruption equilibrium. Paying a wage premium to public sector workers can result in all public sector workers being corrupt. Public sector audits to detect corrupt workers always reduce corruption but can only increase welfare when they are cheap to conduct and the economy is in a low‐corruption equilibrium.

The Role of Economic Freedom in Interpreting Corruption Perception

“…Furthermore, Property Rights, Trade Freedom, and Investment Freedom are the factors that have a significant impact on corruption perception. Similar to the studies in the literature, it is shown that the nexus between marginal tax rate (or total tax burden as a percentage of GDP), which is the major metrics of the Tax Burden dimension, and the corruption perception is highly correlated (Damayanti et al, 2020;Myles & Yousefi, 2020;Le et al, 2020). The relationship between Tax Burden and Corruption is described as it appears that there is less corruption when there is a low tax burden, thus taxpayers are intrinsically motivated to act more honestly and provide accurate information in these studies.…”