Bribes vs. Taxes: Market Structure and Incentives

Firms in developing countries often make informal payments to tax officials. These bribes raise the cost of doing business, and the price charged to consumers. To decrease these costs, we design a feedback incentive scheme for business tax inspectors that rewards them according to the anonymous evaluation submitted by inspected firms. We show theoretically that feedback incentives decrease the bribe size, but make firms facing a more inelastic demand more attractive for inspectors. A tilted scheme that attaches higher weights to the evaluation of smaller firms limits the scope for targeting and decreases the bribe size to a lesser extent. We test both schemes in a field experiment in the Kyrgyz Republic. Our intervention reduces bribes and average business cost. As a result, the price firms charge to consumers decreases. Since fewer firms substitute bribes for taxes, tax revenues increase. Our results show that firms pass-through bribes to consumers, and that market structure shapes the relationship between firms and tax officials.

Joint work with Francesco Amodio, Jieun Choi, and Aminur Rahman.