Keeping it off the Books: An Empirical Investigation of Firms that Engage in Tax Evasion

This paper uses a unique and recently available dataset that contains detailed information on firms from around the world to investigate factors that affect under-reporting behaviour by firms. The empirical strategy employed exploits the nature of the dependent variable, which is interval coded, and uses interval regression which provides an asymptotically more efficient estimator than the ordered probit, provided that the classical linear model assumptions hold. These assumptions are investigated using standard diagnostic tests that have been modified for the interval regression model. Evidence is presented that shows that firms in all regions around the world engage in under-reporting. Regression results indicate that government corruption has the single largest causal effect on under-reporting, resulting in the percentage of sales not reported to the tax authority being 53.4 percent higher. Taxes have the second single largest causal effect on under-reporting, resulting in the percentage of sales not reported to the tax authority being 20.2 percent higher. Access to financing, organized crime, political instability and the fairness of the legal system were found to have no effect on under-reporting. It is also found that there is a significant correlation between under-reporting and the legal organization of the business, size, age, ownership, competition and audit controls.