Corruption and Tax Evasion: Experimental Evidence from China

• In Event: Emerging Scholars in Political Economy

Abstract

Tax compliance is an important topic in the political economy of development. The level of tax evasion is an indicator of people’s conforming to social contracts, and whether they pay enough taxes determines the capacity of states to implement their social policies. Tax payment and collection involve three actors: the government, the tax collector, and the taxpayer. In a normal equilibrium, the taxpayer pays full tax and receives public service from the government. The government gets total tax while providing public goods to payers. Tax collectors should have no personal gains from the collection itself. These interactions form a social contract where payers comply with tax payments, conducted by collectors, and the government provides public goods in exchange.

However, in weak institutional contexts, corruption is a common problem for tax payment. Corruption undermines tax compliance through two possible mechanisms. In an "exchange" situation, the taxpayer pays a bribe to the collector. Bribery enables collectors to receive more and payers to pay less, forming a corrupt exchange where government loses revenue. In a "breach" scenario, bureaucrats ask for briberies for public service that should be free to citizens. Such corruption breaks the social contracts between taxpayers and the government. Thus, payers do not conform to the social contracts and reduce tax payment.

I will conduct lab experiments to address two research questions based on theoretical debates: (1) Does corruption activities impact tax evasion behavior? (2) Which mechanism(s) explain corruption’s impact on tax evasion? I will recruit respondents across China and randomly assign them into four groups. All participants are told to act as "taxpayers." Group 1 is the baseline with no incentive. Group 2 receives a "exchange" incentive, Group 3 receives a "breach" treatment, and Group 4 receives both incentives. I will evaluate the possibility of tax evasion in different groups. By comparing Groups 1 and 2, I evaluate the effect of corrupt exchanges on tax evasion. Comparing Groups 1 and 3 will illustrate whether government’s breaching in public goods provision lowers tax compliance. Finally, Group 4 integrates both mechanisms, revealing how the interaction of corrupt exchanges and breaches influence tax activities.

The study will shed light on the interplay between corruption and tax evasion and apply to weak institutions with widespread corruption and ineffective government supervision.

Author

• Chengyu Fu, Harvard University