Tax Evasion and Firm Survival in Competitive Markets
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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.
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Chapter 5: Tax Evasion, Regulation Evasion and Rent-Seeking

Flip Palda


So far we have seen how when a productive talent is wedded to an unproductive talent, markets select some high cost producers over low cost producers. Firms with high production costs but excellent tax evasion skills could oust from the market competitors with lower production costs but less prominent evasive abilities. Displacement deadweight losses are not the fief of markets with tax evaders. Displacement losses weigh on markets where bureaucrats hand out subsidies, and where governments regulate prices. In all these cases, displacement loss is the consequence of a government that fails to enforce rules evenly. Popular lore equates even enforcement with fairness. Our strongly ingrained sense of the need for fairness is not just a fancy. Previous chapters have shown that fairness ensures efficiency. One of the potential critiques of previous chapters is that I took individual decisions to evade taxes and regulations or to demand subsidies as being fixed, and then explored the general equilibrium consequences of their decisions. I argued in those chapters that allowing some flexibility into individual decisionmaking would not change the tenor of the results. The present chapter backs up this claim by looking at the case of two firms either competing for a subsidy, a tax break, or a monopoly right, or vying with each other to evade taxes. I build a game-theoretic model of competition between two such firms to show that the same sorts of displacement losses arise as in previous chapters, even when individual firm behaviour is allowed to vary....

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