Tax structure and corruption: cross-country evidence

Abstract

One common feature of the current literature on corruption, especially the empirical contributions to it, is the emphasis on the exogenous determinants of corruption, which are generally beyond the direct control of governments. To date, little is known about how the design of government policy potentially affects the level of corruption in a country, even though there is growing recognition that the design and administration of tax and spending policies play important roles in promoting or discouraging corrupt practices. Using a large sample of countries over the 1995–2009 period, this paper fills the gap by conducting the first analysis in the literature to examine the significance of the tax structure, as measured by both tax mix and tax complexity, in determining corruption. Our results suggest the following: (1) countries relying more heavily on direct taxes tend to exhibit less corruption than countries that rely more heavily on indirect taxes, and (2) countries with more complex tax systems tend to be more corrupt than countries with less complex tax systems. These results are robust across alternative measures of corruption and tax structure and alternative estimations with and without correcting the potential endogeneity issue of the tax structure variables.

This is a preview of subscription content, access via your institution.

Fig. 1
Fig. 2

Notes

  1. 1.

    See Seldadyo and de Haan (2006) and Gunardi (2008) for a detailed review of the general determinants of corruption.

  2. 2.

    Studies in the reverse direction in investigating the impacts of corruption on taxation are somehow attracting more attention in the current literature. See, for example, Barreto and Alm (2003), Thornton (2008), Pani (2011) and Alon and Hageman (2013).

  3. 3.

    The income elasticity of the tax system is generally believed to be another main element in the tax system that gives rise to fiscal illusion. The perceptual bias originated from this source is due to the inability of taxpayers to distinguish between increases in taxes derived from a general growth in income and those associated with higher income tax rates. Therefore, countries with high income elasticity tax systems generally accelerate the political approval of the sustainability of more expenditures (Buchanan 1967; Craig and Heins 1980; Baker 1983). The main problem surrounding past empirical studies of the income elasticity hypothesis is that researchers are frustrated by the lack of a suitable measure of income elasticity (Dollery and Worthington 1996). This is true especially for cross-country studies, and for this reason, we do not explore this point further in this paper.

  4. 4.

    Beyond the channel of fiscal illusion, there are other ways through which tax structure may influence corruption. For example, the more complex the tax system, the less transparent the tax system will be, which provides more discretion for officials and creates more opportunities for corruption.

  5. 5.

    For a more detailed discussion, see Sect. 3.3. It should be noted that in order to test the robustness of our results, we also employ alternative measures for both tax mix and tax complexity in the regressions, which are also discussed in Sect. 3.3.

  6. 6.

    In the Freedom House index, both “political rights” and “civil liberties” are originally scaled from 1 (most free) to 7 (least free).

  7. 7.

    It should be noted that the evidence on the relevance of these additional variables is, in general, mixed in the empirical literature.

  8. 8.

    A value of 1 is assigned if two countries share the same border and 0 otherwise.

  9. 9.

    As we will discuss more carefully in Sect. 3.3, the data for our measure of tax complexity are available only from 2006 onward, so the instruments for this variable are the weighted average of tax complexity from neighboring countries as of 2006.

  10. 10.

    It should be noted that we also tried the mean of the weighted average tax structure in the neighboring countries for the observed period as an alternative method to calculate instruments. The regression results are very close to what we present below in Sect. 4.

  11. 11.

    1995 is the earliest year that our principal corruption index measure is calculated.

  12. 12.

    The first World Bank Doing Business report, published in 2003, covered 133 economies.

  13. 13.

    Details are available at http://www.doingbusiness.org/about-us.

  14. 14.

    The data for top statutory personal income tax rates are available only up to 2005, so our working sample is from 1995 to 2005 when this variable enters the specifications.

  15. 15.

    The 2SLS estimation is deemed a more suitable approach for its correction for the potential endogeneity problem.

References

  1. Alesina, A., & Angeletos, G.-M. (2005). Corruption, inequality, and fairness. Journal of Monetary Economics, 52(7), 1227–1244.

    Article  Google Scholar 

  2. Alesina, A., & Wacziarg, R. (1998). Openness, country size and government. Journal of Public Economics, 69(3), 305–321.

    Article  Google Scholar 

  3. Ali, A. M., & Isse, H. S. (2003). Determinants of economic corruption: A cross-country comparison. Cato Journal, 22(3), 449–466.

    Google Scholar 

  4. Alon, A., & Hageman, A. (2013). The impact of corruption on firm tax compliance in transition economies: Whom do you trust? Journal of Business Ethics , 116(3), 479–494.

  5. Andersen, T. B., Bentzen, J., Dalgaard, C.-J., & Selaya, P. (2011). Does the Internet reduce corruption? Evidence from U.S. states and across countries. World Bank Economic Review, 25(3), 387–417.

    Article  Google Scholar 

  6. Baker, S. H. (1983). The determinants of median voter tax liability: An empirical test of the fiscal illusion hypothesis. Public Finance Review, 11(1), 95–108.

    Article  Google Scholar 

  7. Barro, R., & Lee, J. (2010). A new data set of educational attainment in the world, 1950–2010. Journal of Development Economics, 104, 184–198.

  8. Barreto, R. A., & Alm, J. (2003). Corruption, optimal taxation, and growth. Public Finance Review, 31(3), 207–240.

    Article  Google Scholar 

  9. Braun, M., & Di Tella, R. (2004). Inflation, inflation variability, and corruption. Economics and Politics, 16(1), 77–100.

    Article  Google Scholar 

  10. Broadman, H. G., & Recanatini, F. (2001). Seeds of corruption: Do market institutions matter? MOST: Economic Policy in Transitional Economies, 11(4), 359–392.

    Google Scholar 

  11. Brunetti, A., & Weder, B. (2003). A free press is bad news for corruption. Journal of Public Economics, 87(7–8), 1801–1824.

    Article  Google Scholar 

  12. Buchanan, J. M. (1967). Public finance in democratic process. Chapel Hill, NC: University of North Carolina Press.

    Google Scholar 

  13. Buchanan, J. M., & Wagner, R. E. (1978). Dialogues concerning fiscal religion. Journal of Monetary Economics, 4(3), 627–636.

    Article  Google Scholar 

  14. Chand, S. K., & Moene, K. O. (1999). Controlling fiscal corruption. World Development, 27(7), 1129–1140.

    Article  Google Scholar 

  15. Chang, E. C., & Golden, M. A. (2007). Electoral systems, district magnitude and corruption. British Journal of Political Science, 37, 115–137.

    Article  Google Scholar 

  16. Craig, E., & Heins, A. (1980). The effect of tax elasticity on government spending. Public Choice, 35(3), 267–275.

    Article  Google Scholar 

  17. Damania, R., Fredriksson, P., & Mani, M. (2004). The persistence of corruption and regulatory compliance failures: Theory and evidence. Public Choice, 121(3), 363–390.

    Article  Google Scholar 

  18. Dollery, B. E., & Worthington, A. C. (1996). The empirical analysis of fiscal illusion. Journal of Economic Surveys, 10(3), 261–297.

    Article  Google Scholar 

  19. Dollery, B., & Worthingtong, A. (1999). Fiscal illusion at the local level: An empirical test using Australian municipal data. Economic Record, 75(1), 37–48.

    Article  Google Scholar 

  20. Downs, A. (1957). An economic theory of political action in a democracy. Journal of Political Economy, 65, 135.

    Article  Google Scholar 

  21. Escaleras, M., Lin, S., & Register, C. (2010). Freedom of information acts and public sector corruption. Public Choice, 145(3), 435–460.

    Article  Google Scholar 

  22. Fisman, R., & Gatti, R. (2002). Decentralization and corruption: Evidence across countries. Journal of Public Economics, 83(3), 325–345.

    Article  Google Scholar 

  23. Goel, R. K., & Nelson, M. A. (1998). Corruption and government size: A disaggregated analysis. Public Choice, 97(1/2), 107–120.

    Article  Google Scholar 

  24. Goel, R., & Nelson, M. (2011). Government fragmentation versus fiscal decentralization and corruption. Public Choice, 148(3), 471–490.

    Article  Google Scholar 

  25. Goel, R. K., Nelson, M. A., & Naretta, M. A. (2012). The Internet as an indicator of corruption awareness. European Journal of Political Economy, 28(1), 64–75.

    Article  Google Scholar 

  26. Gunardi, H. S. (2008). Corruption and governance around the world: An empirical investigation. Enschede: PPI Publishers.

    Google Scholar 

  27. Gurgur, T., & Shah, A. (2008). Localization and corruption: Panacea or pandoras box? CEMA Working Papers 581. China Economics and Management Academy, Central University of Finance and Economics.

  28. Heyndels, B., & Smolders, C. (1995). Tax complexity and fiscal illusion. Public Choice, 85(1–2), 127–141.

    Article  Google Scholar 

  29. Knack, S., & Azfar, O. (2003). Trade intensity, country size and corruption. Economics of Governance, 4(1), 1–18.

    Article  Google Scholar 

  30. Kotera, G., Okada, K., & Samreth, S. (2012). Government size, democracy, and corruption: An empirical investigation. Economic Modelling, 29(6), 2340–2348.

    Article  Google Scholar 

  31. Kunicová, J., & Rose-Ackerman, S. (2005). Electoral rules and constitutional structures as constraints on corruption. British Journal of Political Science, 35, 573–606.

    Article  Google Scholar 

  32. La Porta, R., Lopez-de Silanes, F., Shleifer, A., & Vishny, R. (1999). The quality of government. Journal of Law, Economics, and Organization, 15(1), 222–279.

    Article  Google Scholar 

  33. Lederman, D., Loayza, N. V., & Soares, R. R. (2005). Accountability and corruption: Political institutions matter. Economics and Politics, 17(1), 1–35.

    Article  Google Scholar 

  34. Lee, Y., & Gordon, R. H. (2005). Tax structure and economic growth. Journal of Public Economics, 89(5–6), 1027–1043.

    Article  Google Scholar 

  35. Mauro, P. (1995). Corruption and growth. The Quarterly Journal of Economics, 110(3), 681–712.

    Article  Google Scholar 

  36. Mill, J. S. (1848). Principles of political economy. Oxford: Oxford University Press.

    Google Scholar 

  37. Misiolek, W., & Elder, H. (1988). Tax structure and the size of government: An empirical analysis of the fiscal illusion and fiscal stress arguments. Public Choice, 57(3), 233–245.

    Article  Google Scholar 

  38. Paldam, M. (2002). The cross-country pattern of corruption: Economics, culture and the seesaw dynamics. European Journal of Political Economy, 18(2), 215–240.

    Article  Google Scholar 

  39. Pani, M. (2011). Hold your nose and vote: Corruption and public decisions in a representative democracy. Public Choice, 148(1), 163–196.

    Article  Google Scholar 

  40. Pommerehne, W. W., & Schneider, F. (1978). Fiscal illusion, political institutions, and local public spending. Kyklos, 31(3), 381–408.

    Article  Google Scholar 

  41. Seldadyo, H., & de Haan, J. (2006). The determinants of corruption literature: Survey and new evidence. In The 2006 EPCS Conference, Turku, Finland (pp. 20–23).

  42. Swamy, A., Knack, S., Lee, Y., & Azfar, O. (2001). Gender and corruption. Journal of Development Economics, 64(1), 25–55.

    Article  Google Scholar 

  43. Tavares, J. (2003). Does foreign aid corrupt? Economics Letters, 79(1), 99–106.

    Article  Google Scholar 

  44. Thornton, J. (2008). Corruption and the composition of tax revenue in Middle East and African economies. South African Journal of Economics, 76(2), 316–320.

    Article  Google Scholar 

  45. Treisman, D. (2000). The causes of corruption: A cross-national study. Journal of Public Economics, 76(3), 399–457.

    Article  Google Scholar 

  46. Wagner, R. (1976). Revenue structure, fiscal illusion, and budgetary choice. Public Choice, 25(1), 45–61.

    Article  Google Scholar 

Download references

Acknowledgments

This paper is supported by Program for New Century Excellent Talents in University (NCET-13-0573) of the Ministry of Education of China. We would like to thank Violeta Vulovic for sharing some of the tax variables data used in this paper. Special thanks to two anonymous referees and the Editor for very helpful comments and suggestions that substantially helped improve the paper.

Author information

Affiliations

Authors

Corresponding author

Correspondence to Yongzheng Liu.

Appendix

Appendix

See Table 7.

Table 7 Description of variables and sources

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Liu, Y., Feng, H. Tax structure and corruption: cross-country evidence. Public Choice 162, 57–78 (2015). https://doi.org/10.1007/s11127-014-0194-y

Download citation

Keywords

  • Tax structure
  • Direct versus indirect taxes
  • Tax complexity
  • Corruption

JEL Classifications

  • D73
  • H20