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Fiscal policy and corruption

  • Bernard Gauthier

    ()

    (Institut d'économie appliquée, HEC Montréal)

  • Jonathan Goyette

    ()

    (Department of Economics and GRÉDI, Université de Sherbrooke)

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 bargaining power over firms in the negotiation of bribes during the tax collection process. In such a situation, the government can choose an optimal policy that involves the joint determination of a tax rate and a probability of detection of corrupt bureaucrats which leads to a no-corruption equilibrium. However, when the public administration is composed of bureaucrats with heterogeneous types defined by their ability to impose red tape costs on firms, we find that it is optimal to allow a certain level of corruption, given the cost of monitoring activities. We show how a government could face lose-lose as well as win-win situations in the conduct of its fiscal policies.

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File URL: http://gredi.recherche.usherbrooke.ca/wpapers/GREDI-1209.pdf
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Paper provided by Departement d'Economique de l'École de gestion à l'Université de Sherbrooke in its series Cahiers de recherche with number 12-09.

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Length: 42 pages
Date of creation: May 2012
Handle: RePEc:shr:wpaper:12-09
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