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The Effect of Fiscal Policy and Corruption Control Mechanisms on Firm Growth and Social Welfare: Theory and Evidence

The paper investigates the conflict that arises between the government, its bureaucrats and businesses in the tax collection process. We examine the effect of fiscal policy and corruption control mechanisms on the prevalence of tax evasion and corruption behaviour, and their impact on firm growth and social welfare. We first model a situation where bureaucrats are homogeneous and have complete negotiating power over the firms with which they interact. We show that in such a situation the government can set an optimal tax rate and put in place a corruption control mechanism involving detection of corrupt bureaucrats within the framework of a no-corruption equilibrium. However, when the public administration is composed of heterogeneous types of bureaucrats with the specific ability to impose red tape costs on firms, we show, like Acemoglu and Verdier (2000), that it might be best for the government to allow a certain level of corruption, given the cost of monitoring activities. We also show that the government could face lose-lose as well as win-win situations in the conduct of its fiscal policies. We then verify the predictions of the model using firm-level data collected from 243 businesses in Uganda. We test the effect of monitoring on bribe and tax payments. We also test the effect of tax rates and corruption control mechanisms on firm growth. We compare the effect of actual corruption (as measured by bribe payments) with the effect of government corruption expectations on firms’ growth.

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Paper provided by HEC Montréal, Institut d'économie appliquée in its series Cahiers de recherche with number 04-10.

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Length: 52 pages
Date of creation: Nov 2004
Date of revision:
Handle: RePEc:iea:carech:0410
Contact details of provider: Postal: Institut d'économie appliquée HEC Montréal 3000, Chemin de la Côte-Sainte-Catherine Montréal, Québec H3T 2A7
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  1. Thierry Verdier & Daron Acemoglu, 2000. "The Choice between Market Failures and Corruption," American Economic Review, American Economic Association, vol. 90(1), pages 194-211, March.
  2. Bernard Gauthier & Ritva Reinikka, 2006. "Shifting Tax Burdens through Exemptions and Evasion: an Empirical Investigation of Uganda," Journal of African Economies, Centre for the Study of African Economies (CSAE), vol. 15(3), pages 373-398, September.
  3. Amemiya, Takeshi, 1979. "The Estimation of a Simultaneous-Equation Tobit Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(1), pages 169-81, February.
  4. Lindauer, David L & Meesook, Oey Astra & Suebsaeng, Parita, 1988. "Government Wage Policy in Africa: Some Findings and Policy Issues," World Bank Research Observer, World Bank Group, vol. 3(1), pages 1-25, January.
  5. Bliss, Christopher & Di Tella, Rafael, 1997. "Does Competition Kill Corruption?," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 1001-23, October.
  6. Besley, Timothy & McLaren, John, 1993. "Taxes and Bribery: The Role of Wage Incentives," Economic Journal, Royal Economic Society, vol. 103(416), pages 119-41, January.
  7. 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.
  8. Basu, Kaushik & Bhattacharya, Sudipto & Mishra, Ajit, 1992. "Notes on bribery and the control of corruption," Journal of Public Economics, Elsevier, vol. 48(3), pages 349-359, August.
  9. Rafael Di Tella & Alberto Ades, 1999. "Rents, Competition, and Corruption," American Economic Review, American Economic Association, vol. 89(4), pages 982-993, September.
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