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Corruption, public finances, and the unofficial economy

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Author Info
Johnson, Simon
Kaufmann, Daniel
Zoido-Lobaton, Pablo

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Abstract

The authors found that, in post-communist economies, the unofficial economy's share of GDP is determined by the extent of control rights held by bureaucrats and politicians. Exploring in detail the role of taxation and bribery, and using data from an expanded data set of 49 Latin American, OECD, and transition economies, the authors find that the unofficial economy accounts for a larger share of GDP where there is great bureaucratic inefficiency and discretion, and where firms experience a greater tax and regulatory burden, as well as more bribery and corruption. The unofficial economy is also much larger where there is less state revenue and where the rule of law is weak. They also find that countries with a larger unofficial economy tend to grow more slowly. Thus, this framework suggests an additional channel whereby corruption and ineffective regulatory and tax administration can result in lower growth: the unofficial economy. Wealthy OECD economies and some Eastern European economies find themselves the"good equilibrium"of relatively low regulatory and tax burden (not necessarily low statutory tax rates), sizable revenue mobilization, good rule of law and control of corruption, and a small unofficial economy. Several countries in Latin America and the former Soviet Union exhibit characteristics consistent with a"bad equilibrium": the discretionary application of heavy regulatory and tax burdens, the weakrule of law, heavy bribery, and an active unofficial economy. In this large country sample (unlike in the earlier framework for transition economies only), the authors find that it is the ineffective and discretionary application of regulatory and tax regimes in many countries -- not higher tax rates by itself -- that increase the size of the unofficial economy. The tax burden reported by firms appears to be more a function of regulatory and bureaucratic inefficiency and discretion rather than of tax rates alone.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2169.

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Date of creation: 31 Aug 1999
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Handle: RePEc:wbk:wbrwps:2169

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Keywords: Environmental Economics&Policies; Knowledge Economy; Economic Theory&Research; Public Sector Economics&Finance; Banks&Banking Reform; Environmental Economics&Policies; Economic Theory&Research; Public Sector Economics&Finance; National Governance; Governance Indicators;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Easterly, William & Rebelo, Sergio, 1993. "Marginal income tax rates and economic growth in developing countries," European Economic Review, Elsevier, vol. 37(2-3), pages 409-417, April. [Downloadable!] (restricted)
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  2. Simon Johnson & Daniel Kaufman & Andrei Shleifer, 1997. "The Unofficial Economy in Transition," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(1997-2), pages 159-240. [Downloadable!]
  3. Sheetal K. Chand & Karl Ove Moene, 1997. "Controlling Fiscal Corruption," IMF Working Papers 97/100, International Monetary Fund.
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  4. Parthasrathi Shome & Vito Tanzi, 1993. "A Primer on Tax Evasion," IMF Working Papers 93/21, International Monetary Fund.
  5. Mauro, Paolo, 1995. "Corruption and Growth," The Quarterly Journal of Economics, MIT Press, vol. 110(3), pages 681-712, August. [Downloadable!] (restricted)
  6. Easterly, William & Loayza, Norman & Montiel, Peter, 1997. "Has Latin America's post-reform growth been disappointing?," Journal of International Economics, Elsevier, vol. 43(3-4), pages 287-311, November. [Downloadable!] (restricted)
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  7. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August. [Downloadable!] (restricted)
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  8. Loayza, Norman V., 1996. "The economics of the informal sector: a simple model and some empirical evidence from Latin America," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 45(1), pages 129-162, December. [Downloadable!] (restricted)
  9. Shleifer, Andrei & Vishny, Robert W, 1994. "Politicians and Firms," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 995-1025, November. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Friedrich Schneider & Christopher Bajada, 2003. "The Size and Development of the Shadow Economies in the Asia-Pacific," Economics working papers 2003-01, Department of Economics, Johannes Kepler University Linz, Austria. [Downloadable!]
  2. Axel Dreher & Friedrich Schneider, 2006. "Corruption and the Shadow Economy: An Empirical Analysis," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  3. Teuea Toatu, 2002. "Unravelling the Pacific Paradox," International and Development Economics Working Papers idec02-2, International and Development Economics. [Downloadable!]
  4. Marco G. Ercolani, 2000. "Inflation Tax and the Hidden Economy," Economics Discussion Papers 509, University of Essex, Department of Economics. [Downloadable!]
  5. Maurizio Bovi, 2003. "The Nature Of The Underground Economy. Some Evidence From Oecd Countries," ISAE Working Papers 26, ISAE - Institute for Studies and Economic Analyses - (Rome, ITALY). [Downloadable!]
  6. Geeta Batra & Daniel Kaufmann & Andrew H. W. Stone, 2004. "The Firms Speak: What the World Business Environment Survey Tells Us about Constraints on Private Sector Development," Microeconomics 0405004, EconWPA. [Downloadable!]
    Other versions:
  7. Laffont, Jean-Jacques, 2001. "Enforcement, Regulation and Development," IDEI Working Papers 129, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
    Other versions:
  8. Teuea Toatu, 2002. "Unravelling the Pacific paradox," Development Economics Working Papers 603, East Asian Bureau of Economic Research. [Downloadable!]
  9. Unal Zenginobuz & Sumru Altug, 2009. "What has been the Role of Investment in Turkey's Growth Performance?," Working Papers 2009/02, Bogazici University, Department of Economics. [Downloadable!]
  10. Ekaterina Vostroknutova, 2003. "Shadow Economy, Rent-Seeking Activities and the Perils of Reinforcement of the Rule of Law," William Davidson Institute Working Papers Series 2003-578, William Davidson Institute at the University of Michigan Stephen M. Ross Business School. [Downloadable!]
    Other versions:
  11. Daniel Kaufmann & Massimo Mastruzzi & Diego Zavaleta, 2003. "Sustained Macroeconomic Reforms, Tepid Growth: A Governance Puzzle in Bolivia?," Development and Comp Systems 0308003, EconWPA. [Downloadable!]
  12. Francisco, Manuela & Pontara, Nicola, 2007. "Does corruption impact on firms'ability to conduct business in Mauritania ? evidence from investment climate survey data," Policy Research Working Paper Series 4439, The World Bank. [Downloadable!]
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