Fiscal Monitor analyzes a selection of tax policies that discriminate between companies in different ways, leading to an inefficient allocation of resources. In this blog, we focus on one: tax evasion. This example is especially relevant for low-income emerging market and developing countries and clearly illustrates how inefficient tax administration negatively affects not only revenue collection, but also productivity.
The Aspect of tax Evasion
Through tax evasion, “cheats” that is, companies registered with the tax authority that declare sales lower than those registered for tax purposes benefit from an implicit subsidy that may be considerable, which allows them to continue operating despite having low productivity. Consequently, “cheats” gain market share despite being less productive, thus reducing the share of more productive companies that meet their tax obligations. The taxes as an independent contractor can be useful on the other hand.
- The foregoing shows us that when the design of a tax aims to achieve “equity”, it necessarily moves away from neutrality. Certainly, neutrality and equity are not compatible.
- It is certainly difficult to conceive of a “neutral” tax, therefore starting from the opposite hypothesis would constitute a major error considering the negative consequences that this could generate in economic policy. This is so, given that if the effects of tax policy (taxes) on economic policy are ignored, this will undoubtedly generate confrontations with the objectives and goals established by it. That is why one of the tasks of tax policy is precisely once the technical structure is chosen, the taxes are designed and therefore the tax burden has been distributed, to analyze its consequences in the economic process.
Therefore, although it is not wrong that neutrality is taken into account when designing taxes in certain situations, we must bear in mind that it can hardly be achieved. Due to the above, we return to the beginning because it does not seem possible to maintain that taxes have the sole purpose of collecting for the State and denying the importance that they have to affect the behavior of the economy and boost it.
What the Results Show
Our results indicate that more rigorous tax administration reduces the prevalence of cheaters. By removing the implicit subsidy, less productive cheaters are unable to compete and are out of business. This opens the way for productive and compliant companies that can increase their market share and absorb more labor and capital, thus increasing aggregate productivity.
According to our estimates, if the productivity gap between compliant firms and noncompliant firms closes in emerging market countries and low-income developing countries, aggregate productivity would increase by ½ to 1 percentage point.
For the countries
All countries have much to gain by eliminating policies and practices that prevent resources from being allocated to areas that allow for higher productivity. In this sense, it is essential to modernize the tax system.