Tax evasion and government size: Evidence from Italian provinces
D’Agostino E., De Benedetto M.A., Sobbrio G., 2021 – Economia Politica
A previous version of the paper has been presented at the 2019 SIEP Conference “Quality of government, economic development and social welfare”, University of Torino
Tax evasion is a widespread phenomenon in a number of economies, and its consequences are often debated among both academics and policymakers. This is particularly true in countries like Italy, where the shadow economy plays a significant role. Unsurprisingly, every year policymakers adopt various measures to fight tax evasion, which obviously change according to the political colour of the government in office. In recent months, for example, the government’s decision to favour the use of cash has raised quite a few controversies. Measures of an opposite nature, trying to fight tax evasion, had been approved by previous executives to encourage the use of electronic money (the so-called cashback and super cashback, later removed by Draghi government).
The paper entitled “Tax evasion and government size: Evidence from Italian provinces”, as written by Elena D’Agostino, Marco Alberto De Benedetto and Giuseppe Sobbrio and recently published in Economia Politica, looks at the breaking of the social agreement between institutions and citizens/taxpayers as a potential explanation of tax evasion, where the party that first fails to comply with the agreement is not represented by citizens who do not pay taxes but, rather, by institutions that do not use public money efficiently and consciously. In this way, the authors attempt to explain tax evasion as the (illegal) reaction of taxpayers to an incorrect (sometimes criminal) behaviour of public institutions.
Specifically, the aim of the research is to verify if there is any relationship between public spending per capita and tax evasion in Italy. To answer this research question, the authors use both data on the “tax gap” at the provincial level, kindly made available by the Italian Revenue Agency, and information on spending of Italian municipalities (collapsed at the provincial level), provided by the Italian Ministry of the Interior, over the 2001-2015 time span. Furthermore, to solve endogeneity issues deriving, for instance, from the presence of characteristics of the provinces which change over time and influence both the taxpayers’ propensity to evade and the level of public expenditure, the authors implement a One-Step System GMM.
The results show that when public spending increases, tax evasion tends to decrease, thus confirming the hypothesis that taxpayers are more likely to contribute to the community’s needs by paying taxes if they see a return in terms of public spending. The authors also evaluate whether the “quality” of public goods and services provided influences the choice to evade taxes. In fact, it is not enough for the government to spend a lot to please citizens; it is also necessary to verify how the revenues deriving from taxation are used and whether public money is wasted.
In this regard, the authors take into account in their analysis that the increase in the size of government could be related, for example, to inefficiencies due to red tape procedures and focus on those expenditures that are more likely to be under the direct control of policymakers, that is, current expenditure per capita, which usually does not constitute the driving force of the economy, but rather serves to satisfy clientelistic needs and electoral promises. Consistent with these expectations, the results of the analysis show that current spending does not affect the propensity to evade taxes. One can therefore deduce that citizens are not positively impressed by the level of current public spending to the point of being more inclined to pay taxes to finance it. Conversely, the results show a downward shift in tax evasion due to an increase in capital spending, i.e. the expenditure which represents a proxy of public investments in the area and is probably less under the direct control of local politicians and bureaucrats.
In the light of these results, the authors attempt to understand who benefits from current public spending and who has the possibility to evade taxes. In order to provide an answer to the first question, they highlight how patronage benefits citizens working in the public administration, whereas subsidies and state aid benefit the unemployed. On balance, these categories of citizens are also those who are less likely to evade. The empirical evidence shows, in fact, that tax evasion lurks in self-employment and among companies. These categories of taxpayers do not benefit much from current public spending, but they are certainly affected by long-term public spending, especially if related to key sectors, such as infrastructures and safety. Consistently with these considerations, the authors show that public spending for investments in these sectors, unlike current expenditure, has a significant and negative effect on tax evasion, thus contributing effectively to fight it.
Finally, since Italian provinces are quite heterogeneous in terms of income, with the South markedly poorer than the North, but tax evasion (public spending) is higher (lower) in the South, the authors also verify whether public spending affects taxpayers’ behaviour differently in these two major geographic areas. The results show a negative effect of public spending on tax evasion in northern regions, which are historically characterised by a relatively larger level of public goods provision.