Impact of institutional environment quality on tax evasion: A comparative investigation of old versus new EU members

Abstract

This paper aims at comparatively investigating the impact of institutional environment quality (IEQ) on tax evasion in old (pre-2004) and new (post-2004) European Union (EU) member states. IEQ is measured by the World Bank’s Worldwide Governance Indicators, which include voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, and control of corruption. The size of their shadow economy is used as a proxy for tax evasion. Using a linear mixed model to analyze the data, the results indicate a higher level of tax evasion in new member states compared to the old member states. Further, our analysis indicates that tax evasion is decreasing in the old member states, but at a lower rate compared to the new EU members. Overall, our results indicate that the relationship between IEQ and tax evasion is different between old and new member states. Specifically, our results indicate that while regulatory quality, voice and accountability, control of corruption, political stability, and government effectiveness are significant determinants of tax evasion levels in older EU members, government effectiveness is the only significant factor in the new EU member states.