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Comment Michael M. Alba 1. Summary Why are economic conditions ...

Source: www.nber.org
Topic: Economic Conditions

Sort Desciption: Why are economic conditionsobviously beside the definitional divide in. incomes and living standardsso different between rich and poor countries? In ...

Content Inside: Comment Michael M. Alba 1. Summary Why are economic conditionsobviously beside the definitional divide in incomes and living standardsso different between rich and poor countries? In developing economies why are inflation and tariff rates higher property rights and the rule of law not well established red tape rife and corruption endemic? Why are government-owned or controlled firms particularly banks so ubiquitous tax evasion so pervasive and the tax base so narrow? In contrast to the political economy literature which points to government capture by politically-powerful groups as the source of these perverse outcomes Gordon and Li (2005a and 2005b) hypothesize that the culprit is a developing-country governments limited capability to enforce tax laws due on the one hand to informational and monitoring constraints when firms transact business on a cash basis thus leaving no record and on the other hand to the low and variable productivity gains that firms obtain when using the financial sector thus providing them little incentive to switch from the tax-evading informal sector to the tax-paying formal sector. Accordingly firms that cannot do without the financial sector such as the large or capital-intensive ones are those that are most highly taxed and that constitute the narrow tax base. In a second-order response the government then acts to reduce the burden on these firms by providing tariff protection rationing credit and subsidizing loans (thus explaining government ownership of banks); at the same time it can increase the costs of informal sector firms by using inflation as a tax on cash holdings and by imposing red tape regulatory barriers to entry and other nontax costs. As an extreme measure the government may even opt for control of capital intensive firms to ensure that although heavily taxed these firms continue to operate at the appropriate scale and capital intensity. To provide a point of comparison Gordon and Li (2005b) also develop a politi ...

michael m alba

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