Tax Evasion and Firm Survival in Competitive Markets

Tax Evasion and Firm Survival in Competitive Markets

Flip Palda

Tax Evasion and Firm Survival in Competitive Markets illustrates how a firm with high production costs but which is easily able to evade taxes may displace from the market a company with low production costs but poor tax evasion capabilities. The difference in production costs between the inefficient survivor and the efficient loser is termed by the author the ‘displacement loss from taxation’, and rivals in size the Harberger triangle loss from taxation.

Chapter 2: Tax Evasion

Flip Palda

Subjects: economics and finance, public choice theory, public finance, politics and public policy, public choice

Extract

In 1990 William Baumol published an instant classic in the Journal of Political Economy. ‘Entrepreneurship: productive, unproductive, and destructive’ was a rare piece for a leading journal. Not a single line of math scarred the pages, nor did Baumol blight the papyrus with charts and figures. Instead, Baumol made his case with a simple bit of economic reasoning. Entrepreneurs are the same the world over and across the ages. They look for new products, new means of producing them, new markets. Whether these entrepreneurs add only to their private fortunes or whether their activities help others depends on the rules of the markets in which they work. If the rules reward entrepreneurs who keep their costs down and devise products or services consumers want, an economy grows. If the rules of markets favour entrepreneurs who cheat, steal, and bribe the government for monopoly power over the market, an economy stagnates or at best grows slowly. In Baumol’s view, the changing character of entrepreneurs and the mix of criminal and honest entrepreneurs was important, but he emphasized the changing rules of the game under which they worked that determined economic progress. Baumol’s article came to be a primer in the 1990s on productive and unproductive entrepreneurship and sensitized the economics profession to the need for rules of the market ‘game’ that make participants play productively. He did not emphasize that the mix of good and bad entrepreneurs could be an important drag on an economy if government did not enforce taxes...

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