Fighting Tax Evasion and Corruption: The Importance of Setting Priorities

Abstract

A serious problem in emerging economies is that of corruption and tax evasion. Its most visible outcomes are resource misallocation, relative price distortions, and distributive inequalities. In this paper we analyze the way in which corruption inside tax agencies in charge of the auditing taxpayers and tax collection, impact over fiscal evasion. We answer two questions. First, should evasion and corruption be attacked simultaneously? Second, are standard anti-corruption mechanisms (such as the increase in penalties) efficient to reduce tax evasion? The model developed here shows that in the presence of auditing corruption, the level of tax evasion is higher and, more importantly, that standard mechanisms using to avoid evasion can actually reduce tax compliance. Furthermore, when facing corruption among tax auditors and evasion, it is important to attack first corruption within tax agencies and, once corruption has been brought under control or eliminated, implement tax compliance policies. Hence, the timing of policies is of the outmost importance.