Firm-oriented policies, tax cheating and perverse outcomes

Abstract

This paper examines the implications of firm-oriented fiscal policies, namely investment subsidies and tax allowances, in an economy where producers may potentially avoid taxes. Among our results we stress the following. First, although investment subsidies induce increased capital accumulation (a level effect), they promote tax evasion; these subsidies induce firms to increase actual capital accumulation (a level effect), but also produce a reduction in the share of aggregate capital stock deployed in taxed, "official" production (a composition effect). Second, parameters characterizing the tax enforcement system play a major role in explaining tax evasion and firm size. Third, the technology structure matters for determining how to allocate resources between official and unofficial production.State aid, tax exemptions, investment subsidies, tax evasion, unofficial underground production, investment