Business culture and tax evasion: Why corruption and the unofficial economy can persist

Abstract

This paper shows that business and tax inspection culture can create multiple equilibria. In bad equilibria (high cheating and corruption), increases in penalties or auditing can have perverse impacts and increase cheating. The source of the multiple equilibria is the externalities created by business and tax inspection cultures. As tax evasion and corruption become more common, they become more acceptable and their cost is lowered. A third externality – that between firms and inspectors – is the source of the perverse effect; more cheating by firms is good for bribe-taking inspectors and more bribe-taking inspectors are good for cheating firms.