Tax Toleration and Tax Compliance: How Government Affects the Propensity of Firms to Enter the Unofficial Economy
How do government-supplied institutional benefits and the taxation and regulation of producers affect the propensity of private firms to enter the unofficial economy and evade taxation? We propose a model in which the incentive of firms to operate underground depends on tax rates relative to firm-specific thresholds of tax toleration that are decisively affected by quality of governance—in particular by the presence of high-grade institutions delivering services enhancing official production that anchor profit-maximizing firms to the official economy. Some key predictions of the model concerning the determinants of firms' tax toleration and tax compliance receive broad support from empirical analyses of enterprise-level data from the World Bank's World Business Environment Surveys.
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Document Type: Research Article
Affiliations: Gothenburg University
Publication date: January 1, 2010