Shadow economy, corruption, and tax performance: A study of BRICS

• Published date: 01 May 2021
• Author: Yadawananda Neog,Achal Kumar Gaur
• Date: 01 May 2021
• DOI: http://doi.org/10.1002/pa.2174

ACADEMIC PAPER

Shadow economy, corruption, and tax performance:

A study of BRICS

Yadawananda Neog | Achal Kumar Gaur

Department of Economics, Banaras Hindu

University, Varanasi, India

Correspondence

Yadawananda Neog, Department of

Economics, Banaras Hindu University, Varanasi

221005, India.

Email: yadawananda.neog3@bhu.ac.in

In this paper, we analyse the effects of economic and political variables on tax

revenue performance of BRICS for the period 1996–2017. After checking unit root

and cointegration of the variables, this study employs fully modified ordinary least

square (FMOLS) to investigate long-run impacts of the explanatory variables. Empiri-

cal results suggest us that, economic development, trade openness and control of

corruption are revenue-enhancing factors for BRICS, whereas the agriculture sector

discourages the tax revenue performance. However, the size of the shadow economy

in BRICS undermines the productive implication of corruption control and economic

development in revenue generation. Based on the results, few policy options are also

discussed in this paper.

1|INTRODUCTION

Corruption remains to be one of the major obstacles for growth in

many developing economies. Economic development requires finance

to adopt developmental expenditure where corruption hinders the fis-

cal capacity to generate enough resources. Attila (2008) and Tanzi &

Davoodi (2000) empirically prove that due to high corruption, tax per-

formance of the developing countries is very low. This is also true for

the case of BRICS economy where the tax–GDP ratio is far low than

the developed nations. Based on the data of World Governance Indi-

cator (WGI) and Medina and Schneider (2018), it is recognized that

there is a high degree of corruption and shadow economy in these

countries. Based on these issues, we are motivated to examine the

impacts of corruption and shadow economy on tax performance in

BRICS with the use of recent data series.

On the theoretical front, corruption can reduce the potential

future tax base by lowering economic growth. Collection of tax is not

a single window transaction between the tax authority and the peo-

ple, it is a process where various stockholders are associated. Due to

the high corruption or corruption perception toward authority, demo-

cratic accountability has been reduced and the prominent reason is

the negative spillover created by corruption across the society. People

tend to avoid taxes, authorities try to be unfair and the government

uses resources for unproductive tasks. Corruption not only reduces

resources for public activities but also public investments in the econ-

omy which ultimately reduce productivity. According to Torgler (2003),

tax morals are high in the system where people find their government

to be not corrupted. Ghosh and Neanidis (2010) have identified three

effects of corruption, (a) reduction in household tax collection,

(b) increase in the government spending and (c) reduction in the gov-

ernment output. Thus, among the macroeconomic factors, corruption

has a major role to play in determining a country's fiscal health, espe-

cially the tax performance. Along with corruption, tax performance is

also determined by the size of the shadow economy. Shadow econ-

omy is mainly regarded as an unaccounted economy, and, theoreti-

cally, an increase in the size of the shadow economy will hurt/boost

the growth based on its interaction with the formal economy (Loayza,

1996; Schneider & Hametner, 2014).

In view with the above discussion, this study tries to answer three

majorquestionsrelatedwithtaxperformanceinBRICSandtheyareas

follows: (a) does the sectoral composition matter for tax collection?,

(b) can control of corruption enhance the tax revenue performance in

BRICS? and (c) is there any impact of shadow economy on tax collection

or not? To answer these questions, we used panel data series for Brazil,

India, China and South Africa for the period 1996–2017. Due to the lack

of data on the tax–GDP ratio, we did not consider Russia in this study.

1.1 |The context of BRICS

Tax performance is generally measured through the tax–GDP ratio

and is an indicator of the capacity of tax collection in an economy by

Received: 6 February 2020 Revised: 25 March 2020 Accepted: 2 May 2020

DOI: 10.1002/pa.2174

J Public Affairs. 2021;21:e2174. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons, Ltd 1of7

https://doi.org/10.1002/pa.2174