Taxation, Corruption, and Growth

Philippe Aghion, Ufuk Akcigit, Julia Cagé, William R. Kerr

NBER Working Paper No. 21928
Issued in January 2016
NBER Program(s):Economic Fluctuations and Growth, Public Economics, Productivity, Innovation, and Entrepreneurship

We build an endogenous growth model to analyze the relationships between taxation, corruption, and economic growth. Entrepreneurs lie at the center of the model and face disincentive effects from taxation but acquire positive benefits from public infrastructure. Political corruption governs the efficiency with which tax revenues are translated into infrastructure. The model predicts an inverted-U relationship between taxation and growth, with corruption reducing the optimal taxation level. We find evidence consistent with these predictions and the entrepreneurial channel using data from the Longitudinal Business Database of the US Census Bureau. The marginal effect of taxation for growth for a state at the 10th or 25th percentile of corruption is significantly positive; on the other hand, the marginal effects of taxation for growth for a state at the 90th percentile of corruption are much lower across the board. We make progress towards causality through Granger-style tests and by considering periphery counties where effective tax policy is largely driven by bordering states. Finally, we calibrate our model and find that the calibrated taxation rate of 37% is fairly close to the model's estimated welfare maximizing taxation rate of 42%. Reducing corruption provides the largest potential impact for welfare gain through its impact on the uses of tax revenues.

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Document Object Identifier (DOI): 10.3386/w21928

Published: Philippe Aghion & Ufuk Akcigit & Julia Cagé & William R. Kerr, 2016. "Taxation, corruption, and growth," European Economic Review, . citation courtesy of

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