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Tax Evasion, Firm Dynamics and Growth

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  • Emmanuele Bobbio

    (Bank of Italy)

Abstract

Italy's growth performance has been lacklustre in the last two decades. The economy has 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, 2017. "Tax Evasion, Firm Dynamics and Growth," 2017 Meeting Papers 683, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:683
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    References listed on IDEAS

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