Taxation and corruption: theory and firm-level evidence from Uganda

Abstract

This article develops a simple framework to analyse the negotiation over bribe and tax payments during the tax collection process. We show that the larger the bribe a firm offers to a tax collector, the larger the tax rebate it gets. More particularly, we show that the negotiation over bribe and tax payments hinges on four other factors: firms' official liabilities, detection, firms' negotiation power and red tape costs imposed on firms. Some of the predictions from the theoretical model are tested using firm-level data from Uganda. We find that bribe and tax payments are inversely related, thereby supporting the hypothesis of a negotiation taking place between firms and tax collectors. In particular, a 1% point increase in average bribe payments per employee is associated with a 7% point reduction in average amount of tax payments per employee. Results are robust to various instruments dealing with the endogenous relationship between bribes and taxes.

Tax Evasion and the Business Environment in Uganda

“…Econometric analyses of the effect of bribery on firm level outcomes, such as tax evasion, are faced with three major econometric issues of concern: (i) challenges due to measurement error in part due to the risk of strategic responses (Fisman and Svensson, ); (ii) both bribery and tax evasion are likely to be jointly determined (Gauthier and Goyette, ); and (iii) reverse causality (Delavallade, ). These challenges pose serious endogeneity concerns.…”

“…For these reasons we estimate the models using the instrumental variable methods controlling for the possible endogeneity bias. Following Angrist and Krueger (), Fisman and Svensson (), and Gauthier and Goyette () we exploit grouped averages for bribery outcomes computed at the geographic firm‐location as suitable instruments. In computing the geographic firm‐location averages, we excluded the amount of bribes paid by the firm for which the average is computed.…”

Bribery environments and firm performance: Evidence from CEE countries

“…Higher bribes or frequency of bribing can alter firms' incentives to grow, such that they prefer to remain small and less visible to public officials (Gauthier and Goyette, 2014).…”

“…Smaller (micro) firms are often required to comply with softer regulatory standards such as reporting and keeping records for inspections. They may also be exempted from some taxes, or have lower tax rates (Gauthier and Goyette, 2014).…”

Distortions, efficiency and the size distribution of firms

“…Based on Goyette (2014), the size-threshold into formality, l ic , is set at 30 employees, 19 the ratio of tax obligations per sale found in the data is s 0 ¼ 0:14. The effective rate of taxes paid, s p , is half the official rate (Gauthier and Goyette, 2014). Audit probabilities for small and larger firms are also taken from the data and set to 0.53 and 0.71 respectively.…”