Tax, lies, and red tape

Weak institutional environments in poor countries may lead to lower tax compliance by firms. This may be especially true for family firms, whose owners have higher stakes in the firm and longer horizons, increasing their incentives for evasion, as well as access to local networks and information, increasing their opportunities for evasion.

This project uses firm-level data from manufacturing firms in India to examine whether continued involvement of the founding family leads to lower tax compliance.

Tax evasion is well-recognised as a serious concern by the Indian government, but despite tax authorities being aware of high evasion, resource constraints and weak geographical connectivity across the country prevent proper surveillance of firm production activity, and weak coordination between regulators make detecting evasion difficult. There is strong policy demand for research to identify characteristics of firms that are not fulfilling their tax obligations, as well as for recommendations for tax structures and new strategies to help reduce evasion.

India also has a high share of family-owned enterprises compared to other countries. If these family firms are smaller and less productive, the lower effective tax rates they can get through evading taxes helps them continue producing and competing with more productive firms, as well as creating barriers to entry for new firms. This “wedge” between prices faced by firms with different ownership and productivities will mean that there is misallocation among firms, distorting size and productivity distributions in the economy.

Data will be sourced from the two leading sources of formal sector establishments in India. The first is CMIE Prowess, which contains information for the larger, listed manufacturing firms. Listed firms have to disclose their shareholding patterns, which helps identify family ownership as well as involvement of family in firm management for about 2,000 firms. The second source is data from the Annual Survey of Industries (ASI), which provides product-level output data for about 60,000 establishments every year from a random sample. From the ASI data, estimates of tax evasion can be made with less measurement than firm level data, as it includes product level reporting of quantities, sales, and excise payments.