Corruption, Public Finances, and the Unofficial Economy

51 Pages Posted: 25 Feb 2000

See all articles by Simon Johnson

Simon Johnson

Massachusetts Institute of Technology (MIT) - Entrepreneurship Center; National Bureau of Economic Research (NBER)

Daniel Kaufmann

Natural Resource Governance Institute (NRGI); The Brookings Institution

Pablo Zoido

Stanford University - Graduate School of Business

Date Written: August 1999

Abstract

In this sample of 49 Latin American, OECD, and transition economies, it is the ineffective and discretionary administration of tax and regulatory regimes--not higher tax rates alone--as well as corruption, that increases the size of the unofficial economy. And countries with a larger unofficial economy tend to grow more slowly.

Johnson, Kaufmann, and Shleifer (1997) found that, in post-communist economies, the unofficial economy's share of GDP is determined by the extent of control rights held by bureaucrats and politicians.

Exploring in detail the role of taxation and bribery, and using data from an expanded data set of 49 Latin American, OECD, and transition economies, Johnson, Kaufmann, and Zoido-Lobaton find that the unofficial economy accounts for a larger share of GDP where there is great bureaucratic inefficiency and discretion, and where firms experience a greater tax and regulatory burden, as well as more bribery and corruption.

The unofficial economy is also much larger where there is less state revenue and where the rule of law is weak. They also find that countries with a larger unofficial economy tend to grow more slowly.

Thus, this framework suggests an additional channel whereby corruption and ineffective regulatory and tax administration can result in lower growth: the unofficial economy.

Wealthy OECD economies and some Eastern European economies find themselves in the "good equilibrium" of relatively low regulatory and tax burden (not necessarily low statutory tax rates), sizable revenue mobilization, good rule of law and control of corruption, and a small unofficial economy.

Several countries in Latin America and the former Soviet Union exhibit characteristics consistent with a "bad equilibrium": the discretionary application of heavy regulatory and tax burdens, the weak rule of law, heavy bribery, and an active unofficial economy.

In this large country sample (unlike in the earlier framework for transition economies only), the authors find that it is the ineffective and discretionary application of regulatory and tax regimes in many countries--not higher tax rates by itself--that increase the size of the unofficial economy.

The tax burden reported by firms appears to be more a function of regulatory and bureaucratic inefficiency and discretion rather than of tax rates alone.

This paper - a product of the Governance, Regulation, and Finance Group, World Bank Institute - is part of a larger effort in the institute to improve our understanding of institutional issues and their effects on development and of building a major new database on institutional indicators.

JEL Classification: E00,H00,O10,O1,O17,P5,M5,K0,H0,H1,K4

Suggested Citation

Johnson, Simon and Kaufmann, Daniel and Zoido, Pablo, Corruption, Public Finances, and the Unofficial Economy (August 1999). World Bank Policy Research Working Paper No. 2169. Available at SSRN: https://ssrn.com/abstract=192569

Simon Johnson

Massachusetts Institute of Technology (MIT) - Entrepreneurship Center ( email )

United States
617-253-8412 (Phone)
617-258-6855 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Daniel Kaufmann

Natural Resource Governance Institute (NRGI) ( email )

80 Broad Street
New York, NY 10004
United States

HOME PAGE: http://www.resourcegovernance.org

The Brookings Institution ( email )

1775 Massachusetts Avenue, NW
Washington, DC 20036
United States

HOME PAGE: http://www.brookings.edu/experts/kaufmannd

Pablo Zoido (Contact Author)

Stanford University - Graduate School of Business ( email )

Stanford, CA 94305
United States

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