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Corruption, public finances, and the unofficial economy

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Author Info

  • Johnson, Simon
  • Kaufmann, Daniel
  • Zoido-Lobaton, Pablo

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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Bibliographic Info

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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Related research

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;

References

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  1. Loayza, Norman A., 1997. "The economics of the informal sector : a simple model and some empirical evidence from Latin America," Policy Research Working Paper Series 1727, The World Bank.
  2. 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.
  3. 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.
  4. Shleifer, Andrei & Vishny, Robert W, 1994. "Politicians and Firms," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 995-1025, November.
  5. 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.
  6. Vito Tanzi & Parthasrathi Shome, 1993. "A Primer on Tax Evasion," IMF Working Papers 93/21, International Monetary Fund.
  7. Sheetal K. Chand & Karl Ove Moene, 1997. "Controlling Fiscal Corruption," IMF Working Papers 97/100, International Monetary Fund.
  8. Mauro, Paolo, 1995. "Corruption and Growth," The Quarterly Journal of Economics, MIT Press, vol. 110(3), pages 681-712, August.
  9. 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(2), pages 159-240.
  10. Vito Tanzi & Parthasarathi Shome, 1993. "A Primer on Tax Evasion," IMF Staff Papers, Palgrave Macmillan, vol. 40(4), pages 807-828, December.
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