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Tax evasion, firm dynamics and growth

Listed author(s):
  • Emmanuele Bobbio

    ()

    (Banca d'Italia)

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    Italy's growth performance has been lacklustre in the last two decades. The economy has a low R&D intensity; firms are smaller and less likely to grow or exit than firms in other advanced countries; the shadow economy is large. I show how these features arise simultaneously in a Schumpeterian growth model with heterogeneous firms where the tax auditing probability increases with firm size. Tax evasion confers a cost advantage over competitors. In equilibrium, small firms invest less in innovation because growing entails a (shadow) cost of fiscal regularization. Unfair competition forces other firms to lower the mark-up they charge for their new products, reducing the incentive to innovate. Market selection is hampered, further lowering the aggregate growth rate along the extensive margin. I calibrate the model on Italian firm-level data for the period 1995-2006 and find that enforcing taxes would have increased the long-run growth rate from 0.9% to 1.1%. The market share of high type firms would have been 8 percentage points higher and average firm size 25% higher. Also, I find that lowering the tax burden can have a significant impact on growth when the shadow economy is large, while the effect is negligible when taxes are enforced.

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    File URL: http://www.bancaditalia.it/pubblicazioni/qef/2016-0357/QEF_357_16.pdf
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    Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Questioni di Economia e Finanza (Occasional Papers) with number 357.

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    Date of creation: Sep 2016
    Handle: RePEc:bdi:opques:qef_357_16
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