Information sharing, bank penetration and tax evasion in the developing countries

Abstract

In April 2016, a huge leak of confidential documents regarding tax affairs, known as “Panama papers”, occurred. This leak has revealed information in relation to the way in which the rich has hidden their assets to evade tax with the assistance of a Panamanian law firm, known as Mossack Fonseca. The consequences have spread around the world for months, and possible for years, which has been considered as one of the biggest global scandals in relation to tax evasion at all times. A question has been put forward in relation to the approach in which the governments of many countries, regardless of the economic development of the nation, have adopted to really manage tax evasion being consistently occurred in the economy. This study is conducted in response to this important and hotly debated issue regarding tax evasion. Shadow economy refers to taxable business activities but failed to be reported by financial/ tax authority. As a result of shadow economy, tax evasion defines illegal activities which aim to conceal taxable income from tax authorities or to include expenses which are not allowed in order to reduce tax liabilities to be paid to the coffers of the governments. Tax evasion and shadow economy are critical problems and barriers to growth, regardless of the level of economic development of a nation. However, it is argued that the issue of tax evasion is more serious and difficult to be handled in developing countries in comparison with the developed nations. An extensive literature review in this study presents that (i) tax and social security contribution burdens, (ii) regulations, (iii) public sector services, (iv) quality of institutions and (v) tax compliance play an important role in the decision of whether or not firms would evade tax. Three contributions of this study can be summarized as below. First, on the ground of this literature review and other empirical studies, the so-called tax evasion index (TEI) is developed to measure tax evasion in the developing countries. Second, potential influences of information sharing and bank penetration from financial intermediate developments on tax evasion is examined using the newly developed TEI. Third, potential contributions of firms’ characteristics including firm size and location to the relationship between information sharing, bank penetration and tax evasion is discussed and quantified. The sample consists of 112 developing countries during the period of 2006 to 2014 using data from standardized World Bank Enterprises survey 2006 – 2014. The new TEI is constructed by calculating equally weighted average of five indicators which represent the main five sources of influence. This new index falls within the range of 0 to 1. As such, Tobit regression is utilized to examine the relationship between information sharing, bank penetration and tax evasion. Findings from this study indicate that there is a substance variance in relation to tax evasion, which is proxied by the new TEI in this study, among 112 countries adopted in the research sample. The difference of the TEI across countries is mostly explained by the difference in public sector services. Corruption contributes the largest part to the estimate of the TEI with the average of 2.76 over the maximum of 4. The average TEI for developing countries in the sample stays at 0.62 with the lowest estimate of 0.25 (for Etritrea) and the highest estimate of 0.7539 (for Brazil). In addition, empirical analyses indicate a consistent and negative relationship between information sharing, bank penetration and tax evasion in developing countries. Finally, large firms are generally considered to have adopted good tax compliance practices while firms located in remote areas are more likely to evade tax.