Abstract
Several empirical papers have shown that corruption is an impediment to growth, as it mainly constitutes hindrance to investment. While there are few theoretical studies linking corruption and growth, none of the existing papers can ex-plain the fall in the growth-maximizing tax rate of the economy following reduction in corruption. We present an en-dogenous growth model where corruption hinders investment and decreases the growth-maximizing tax rate of the economy. Incentives to invest in private capital fall as the corrupt government diverts some portion of the tax revenue away from investment in public capital that has an impact on the return of private inputs. We show, using a nonlinear (concave) relationship between the intensity of corruption and the amount of wasted resources that reducing corruption can be beneficial not only to growth, but to the average taxpayer in the economy as the tax rate would fall.
Highlights
Corruption remains one of the major obstacles to economic prosperity in many countries
This paper presents a simple endogenous growth model where corruption hinders investment
In the presence of corruption, government diverts a part of tax revenues away from investment in public capital, which in turn is a necessary input in private production
Summary
Corruption remains one of the major obstacles to economic prosperity in many countries. It is known to distort incentives, impede investment and divert the allocation of productive resources to rent-seeking activities (Murphy, Shleifer & Vishny [1]) These detrimental effects are likely to slow growth. We show that curbing corruption raises the maximum possible growth rate, but it lowers the growth-maximizing tax rate by stretching the “growthpossibility frontier” upward and to the left. To our knowledge, this theoretical illustration is novel and has not been presented in endogenous growth literature or in the literature on corruption
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