Corruption and supply-side economics

Abstract

This paper develops a model of the effects of tax rates chosen optimally to promote growth and public welfare in the face of corruption. For a given level of corruption, public spending can promote growth but high tax rates in pursuit of various social goals have potentially significant supply-side economics effects that reduce income. Governments faced with rampant corruption optimally choose low tax rates, thus associating poor countries with low tax rates, and confounding the observed relation between tax rates and income. The model is estimated using cross-country data on income, tax rates, and corruption and is shown to match key features of the data. The chief contribution of this paper is to stress the importance of jointly considering the effects of corruption and taxation in documenting evidence in support of supply-side economics.