Corruption and Tax Structure in American States

• Author: John L. Mikesell,Cheol Liu
• Published date: 01 July 2019
• Date: 01 July 2019
• DOI: 10.1177/0275074018783067
• Subject Matter: Articles

https://doi.org/10.1177/0275074018783067

American Review of Public Administration

2019, Vol. 49(5) 585 –600

© The Author(s) 2018

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DOI: 10.1177/0275074018783067

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Article

Introduction

Kaufmann (2010) provocatively asks “whether corruption

may adversely affect public finances in industrialized coun-

tries?” An abundant literature has focused on corruption

impacts in developing and transition countries (Fjeldstad &

Tungodden, 2003; Ghura, 1998; Grimes & Wängnerud, 2010;

Moloney & Chu, 2016; Ohemeng & Owusu, 2015; Tanzi &

Davoodi, 1997; Themudo, 2014) and a new literature is find-

ing impacts of corruption on American state finances

(Bayoumi, Goldstein, & Woglom, 1995; Butler, Fauver, &

Mortal, 2009; Depken & LaFountain, 2006; Liu, Moldogaziev,

& Mikesell, 2017; Maher, Deller, Stallmann, & Park, 2016;

Moldogaziev, Liu, & Luby, 2017). This article extends this

examination of corruption impacts by considering whether

corruption in American states might impact the structures used

to raise tax revenue.

Corruption means “misuse of public office for private

gain” and, given the capacity of a tax system to distribute

costs among private entities, it would not be surprising to

find an impact of corruption on that system of distribution.

Corrupt officials may be susceptible to illegal inducements

from private entities interested in changing the tax structure

to their advantage. Although a number of scholars have

investigated the causes, consequences, and cures of corrup-

tion, corruption impacts on tax systems have not been inves-

tigated. Liu (2017) surveys the existing literature about the

causes, consequences, and cures of corruption. Furthermore,

the challenges of governance and corruption in the industrial-

ized world have been less-examined than has its impact in

developing countries (Kaufmann, 2010). If government finance

systems can be distorted for private gain, there is ample reason

to examine whether public corruption might impact the struc-

tures used to raise revenue for public pr ograms. M oving the

cost of government to others and hiding those economic

impacts can be of considerable economic advantage to those

with influence.

Developed countries likely have a higher level of tax

compliance and tax morale than do developing ones.

However, evidence of the impact of corruption on other ele-

ments of the fiscal system raises a suspicion that tax systems

might be influenced as well. It is a question not previously

examined. This article fills this gap by examining how cor-

ruption affects the level and composition of tax revenue in

the U.S. state and local governments over the period 1997-

2013. We examine how public corruption is associated with

the level of tax burden, the extent of tax progressivity, and

the degree of tax transparency across the states.

Literature Review and the Logic

of Corruption Influence

Businesses and individuals may reduce their tax obligations

by three general approaches. First, they may take illegal and

intentional actions to reduce their tax obligations. They may

evade “by underreporting incomes; by overstating deduc-

tions, exemptions, or credits; by failing to file appropriate tax

returns; or even by engaging in barter to avoid taxes” (Alm,

Martinez-Vazquez, & McClellan, 2016). Traditional tax eva-

sion theory is often utilized to explain the corruption effects

on the tax structure of the developing countries and the

783067ARPXXX10.1177/0275074018783067The American Review of Public AdministrationLiu and Mikesell

research-article2018

1KDI School of Public Policy and Management, Sejong, Republic of Korea

2School of Public and Environmental Affairs, Indiana University,

Bloomington, USA

Corresponding Author:

Cheol Liu, KDI School of Public Policy and Management, 263 Namsejong-

ro Sejong-si (S445), Sejong, 30149, Republic of Korea.

Email: cliu@kdischool.ac.kr

Corruption and Tax Structure in American States

Cheol Liu1 and John L. Mikesell2

Abstract

We examine the extent to which public corruption influences the tax structure of American states. After controlling for

other tax structure influences, we find that states with greater measured public corruption have more complex tax systems,

have higher tax burdens, rely more heavily on regressive indirect taxes, and have smaller shares of their tax burdens with

initial impact on business. These are significant structural impacts on the tax systems.

Keywords

corruption, fiscal illusion, indirect tax, tax regressivity, tax share by business

586 American Review of Public Administration 49(5)

transition economies (Fjeldstad & Tungodden, 2003; Ghura,

1998; Tanzi & Davoodi, 1997).

Second, they may structure their operations to reduce

their tax liabilities through legal means. That includes taking

advantages of deductions, exemptions, or credits provided in

the law; by timing transactions to reduce liabilities; by struc-

turing transactions to take advantage of lower tax rates pro-

vided in the law; and so on. These avoidance actions reduce

tax obligations but, in contrast to the evasion tactics, are

legal within the existing law. Avoidance activities are recog-

nized as acceptable in a Supreme Court case: “The legal right

of a taxpayer to decrease the amount of what otherwise

would be his [or her] taxes, or altogether avoid them, by

means which the law permits, cannot be doubted” (Gregory

v. Helvering, 293 U.S. 465 [1935]).

Third, businesses and individuals may reduce their tax

obligations by changing the tax law so that liabilities are

reduced within the scope of that law. That approach requires

influence on lawmakers and tax administrators and that

opens the door for use of corrupt practices. If corrupt entities

can induce a tax structure favorable to their interests, they

can reduce their own tax burden as long as the tax structure

stays in place and they are freed from the need to aggres-

sively practice avoidance or evasion. When there are corrupt

public officials, this approach may be the most efficient for

entities working to reduce tax burdens.

The largest impact of corruption on tax systems may,

however, be in regard to burden transparency. Any manner of

tax system manipulation for gain of public officials and their

associates would be easier if the general public is unaware of

tax structures and tax burden distribution. Hence, public cor-

ruption may be expected to have an impact on tax structures

not only in regard to the burden patterns they produce but

also, critically, in regard to the degrees to which the system

itself operates in transparent fashion. A fiscal illusion, par-

ticularly in regard to taxpayer misperceptions about the level

and structure of the tax system, would be an invaluable tool

for public corruption. Indeed, fiscal illusion may facilitate all

other manipulation of the tax system to restructure, redistrib-

ute, or change tax burdens within the law. Consideration of

the impact of corruption on fiscal illusion is critical for the

present analysis.

While there is a paucity of analysis of the impact of public

corruption on tax structure, there are many studies on the

association between corruption and tax evasion. These stud-

ies focus on public officials’ “self-seeking” behaviors from

taxpayers who have the intent to avoid taxation. They follow

the household income tax evasion model of Allingham and

Sandmo (1976); corruption and high tax rates (Chander &

Wilde, 1992); wage incentives system to curb corruption

(Besley & McLaren, 1993); optimal design of tax collection

schemes (Hindriks, Keen, & Muthoo, 1999); and size of bribe

and tax evasion (Akdede, 2006). Others focus on evasion

efforts by firms which evade their tax obligations by under-

reporting their income and sales, by overstating deductions,

and by failing to file their tax returns (Rice, 1992; Wang &

Conant, 1988); audit selection rules and firm compliance

(Alm, Blackwell, & McKee, 2004; Murray, 1995); contrac-

tual relationship between shareholders and tax managers

(Crocker & Slemrod, 2005); market distortion due to tax eva-

sion by firms (Goerke & Runkel, 2006); corruption activities

by firms (Goerke, 2008); corruption and tax compliance in

the transition economies (Uslaner, 2010); and the association

between the size of bribes and corporate income tax evasion

(Alm et al., 2016; Wu, 2005).

Another group of evasion studies focuses on the macro-

economic consequences of corruption on taxation, often con-

necting corrupt activities by public officials with the various

aspects of their fiscal and tax policies. Allowing tax auditors

to accept bribe can decrease the amount of revenue collected

(Chander & Wilde, 1992). Corruption reduces the tax collec-

tion of governments when corruption contributes to tax eva-

sion, improper tax exemptions, or poor tax administration

(Alm, Bahl, & Murray, 1991; Friedman, Johnson, Kaufman,

& Zoido-Lobaton, 2000; Gupta, 2007; Ivanyna, Moumouras,

& Rangazas, 2016; Johnson, Kaufmann, & Zoido-Lobaton,

1999; Sanyal, Gang, & Goswami, 2000; Tanzi & Davoodi,

1997). In contrast, some studies argue that corruption can

reduce tax evasion and increase tax revenue as a conse-

quence. When expected benefit from corruption, for exam-

ple, bribes, is high, a tax collector has incentives to monitor

taxpayers more intensively. This increases the expected cost

to taxpayers of evading taxes, which results in a lower level of

tax evasion and a higher level of tax collection. This positive

effect of corruption on tax revenue actually happened in the

developing countries (Chand & Moene, 1999; Mookherjee,

1997), although Fjeldstad and Tungodden (2003) conclude

that this is a short-term phenomenon, at best, and disappears

in the long run.

Most of these macroeconomic analyses examine the

association between corruption and the level of government

tax revenue in developing and transition economies, not

developed economies. The contexts of the developing and

the transition economies differ from that of the developed

countries. The average tax revenue to gross domestic prod-

uct ratio in the developed world, approximately 35%, is

much higher than the developing countries in which the

ratios range from 12% to 15% (Cobham, 2005), possibly

because of lower tax evasion in the developed societies.

Often more than half of the taxes that should be collected

cannot be traced by the government treasuries due to corrup-

tion and tax evasion (Fjeldstad & Tungodden, 2003). Tanzi

(1996) notes that corruption may be more common at local

than at the national level, although less severe in developed

countries.

The links between corruption and tax evasion found in

developing countries cannot be directly transferred to the

United States. The tax morale of Americans, meaning “the

intrinsic motivation to pay taxes,” is found to be higher than

even that of Europeans, which is expected to result in high