Keeping it off the books: an empirical investigation of firms that engage in tax evasion

Abstract

This paper uses a unique and recently available dataset that contains detailed information on firms from around the world to investigate factors that affect under-reporting behaviour by firms. The empirical strategy employed exploits the nature of the dependent variable, which is interval coded, and uses interval regression which provides an asymptotically more efficient estimator than the ordered probit, provided that the classical linear model assumptions hold. These assumptions are investigated using standard diagnostic tests that have been modified for the interval regression model. Evidence is presented that shows that firms in all regions around the world engage in under-reporting. Regression results indicate that government corruption has the single largest causal effect on under-reporting, resulting in the percentage of sales not reported to the tax authority being 53.4 percent higher. Taxes have the second single largest causal effect on under-reporting, resulting in the percentage of sales not reported to the tax authority being 20.2 percent higher. Access to financing, organized crime, political instability and the fairness of the legal system were found to have no effect on under-reporting. It is also found that there is a significant correlation between under-reporting and the legal organization of the business, size, age, ownership, competition and audit controls.

Formalizing the Shadow Economy in Serbia

“…5 We interpret this as the odds of the entrepreneurs taking part in the shadow economy vs. the odds of the business's chance of doing so (while other independent variables remain unchanged). These results are in accordance with the findings of other studies, according to which entrepreneurs are more engaged in the shadow economy than other types of business (Tedds 2010;Williams 2006). We can interpret the VAT-payer coefficient in a similar manner.…”

“…However, the relationship between the shadow economy and business entity size whereby smaller businesses are more likely to participate in the shadow economy (Tedds 2010;Williams 2006) cannot be confirmed.…”

“…The typical link between the shadow economy and the size of the business, whereby businesses with fewer workers are more likely to engage in the shadow economy (Rice 1992;Hanlon et al 2007;Tedds 2010;Williams 2006), is not as pronounced in Serbia. The shadow economy is mainly the domain of businesses with between 5 and 19 employees and large businesses with 250 or more employees.…”

“…There have been far fewer studies analysing the characteristics of businesses engaged in the shadow economy and the factors that drive them to operating informally. Exceptions are research on the shadow economy in Bulgaria and the Baltic States (Estonia, Lithuania, and Latvia) based on data from the survey of businesses operating informally, and a study on the impact of the shadow economy on the operation and competitiveness of businesses in South Eastern Europe, based on data from the Business Environment and Enterprise Performance Study (BEEPS) (Kyle et al 2001;Williams 2006;Tedds 2010;Hudson et al 2012).…”

Causes of the Shadow Economy

“…Empirical research carried out worldwide, including in Serbia (see Chap. 6 of this study) shows that the shadow economy is at its most widespread with entrepreneurs and small and micro-businesses (Tedds 2010;Williams 2006). Although comparative data indicate that the structure of Serbia's economy, in terms of the number of small, medium-sized, and large businesses, is similar to that of EU member states, it has been estimated that the current ratio of Tax Administration staff effectively engaged in tax audit to the number of taxpayers is relatively unfavourable.…”