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Tax evasion, firm dynamics and growth

Author

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  • Emmanuele Bobbio

    () (Banca d'Italia)

Abstract

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.

Suggested Citation

  • Emmanuele Bobbio, 2016. "Tax evasion, firm dynamics and growth," Questioni di Economia e Finanza (Occasional Papers) 357, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:opques:qef_357_16
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    References listed on IDEAS

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    More about this item

    Keywords

    growth; innovation; selection; firm dynamics; tax evasion; size dependent policies;

    JEL classification:

    • O30 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - General
    • O43 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Institutions and Growth
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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