Tax, Lies & Red Tape

Weak institutional environments in poor countries lead to low tax compliance, especially for family firms, where owners have high-powered incentives and managerial control. These family firms tend to be smaller and less productive, indicating that the lower effective tax rates may help them continue to enter the market and produce instead of being driven out by competition. This diverts resources away from larger, more productive firms and reduces aggregate output and productivity. This hinders new entrepreneurs from entering the market, deterring innovation. This mechanism is reinforcing and could ultimately prevent developing countries from rising out of poverty. I seek to further understand the channels through which tax evasion is carried out. I will be meeting the Tax division of the Ministry of Finance in New Delhi and auditors and the staff of the security markets regulator in Mumbai, who have several years of experience with Indian firms and understand the channels through which evasion occurs. I will use this to further understand and identify these channels in the data. This will help address both the ultimate reasons behind tax evasion as well as guide policy recommendations on how to curb it.