Corruption, Growth, and Taxation

Abstract

Several empirical papers have shown that corruption is an impediment to growth, as it mainly constitutes hindrance to investment. While there are few theoretical studies linking corruption and growth, none of the existing papers can ex-plain the fall in the growth-maximizing tax rate of the economy following reduction in corruption. We present an en-dogenous growth model where corruption hinders investment and decreases the growth-maximizing tax rate of the economy. Incentives to invest in private capital fall as the corrupt government diverts some portion of the tax revenue away from investment in public capital that has an impact on the return of private inputs. We show, using a nonlinear (concave) relationship between the intensity of corruption and the amount of wasted resources that reducing corruption can be beneficial not only to growth, but to the average taxpayer in the economy as the tax rate would fall.