Tax Evasion in a Corrupt Economy

Tax evasion has been studied intensively in the context of developed countries in which the institutional environment assumes a pervasive respect for the rule of law. In many developing nations such an assumption is not warranted. The objective of this paper is to develop a model of tax evasion apposite to an institutional set up in which corruption is endemic. The services of corrupt intermediaries are required by otherwise legitimate producers in order to navigate the informal 'laws' put in place by rent seekers with good connections. The model developed here posits a service providing industry which produces legitimate public services and corrupt intermediation as joint products which exploit economies of scope available to senior bureaucrats. The model can be used in various ways; in this paper a cut in the tax rate on income from capital is examined. Under certain conditions such a cut can lead to increased government revenue, giving a new explanation of how a kind of Laffer curve may operate in economies with endemic corruption.