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The Effect of Low Corporate Tax Rate on Payroll Tax Evasion

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  • Boryana Madzharova

Abstract

It is a commonly held view that the widespread policy of cutting the corporate income tax has a positive effect on taxable income through decreasing firms' incentive to hide profits. A neglected side of this policy, however, is its potential to trigger more evasion in other tax bases, such as the social security base, especially if the corporate income tax rate is low compared to the payroll rate. We develop a model in which employers and employees cooperate in declaring lower wages to the tax authorities in order to evade payroll contributions. Since wages and payroll taxes are a deductible expense for firms, a lower reported wage translates into higher corporate profits on paper and hence, shifting of tax liability out of social security into the corporate tax base. Using firm-level panel data for Bulgaria, where the problem of contribution evasion is prevalent, we find that a 1% increase in the net-of-tax-share of the corporate tax rate reduces reported wages in the economy by .21%, but leads to higher taxable incomes. An identical increase in the payroll net-of-tax-share results in a .28% rise in wages. Thus, even though the separate tax bases respond significantly to changes in the corporate tax rate, the impact on the combined tax base of wages and taxable incomes is estimated to be small.

Suggested Citation

  • Boryana Madzharova, 2011. "The Effect of Low Corporate Tax Rate on Payroll Tax Evasion," CERGE-EI Working Papers wp448, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
  • Handle: RePEc:cer:papers:wp448
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    File URL: http://www.cerge-ei.cz/pdf/wp/Wp448.pdf
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    References listed on IDEAS

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    1. Gruber, Jon & Saez, Emmanuel, 2002. "The elasticity of taxable income: evidence and implications," Journal of Public Economics, Elsevier, vol. 84(1), pages 1-32, April.
    2. Allingham, Michael G. & Sandmo, Agnar, 1972. "Income tax evasion: a theoretical analysis," Journal of Public Economics, Elsevier, vol. 1(3-4), pages 323-338, November.
    3. Yaniv, Gideon, 1988. "Withholding and non-withheld tax evasion," Journal of Public Economics, Elsevier, vol. 35(2), pages 183-204, March.
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    More about this item

    Keywords

    corporate tax; payroll tax; evasion; wage underreporting;

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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