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

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS INFORMATION SHARING, BANK PENETRATION & TAX EVASION IN THE DEVELOPING COUNTRIES BY VO MANH TAN MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, NOVEMBER 2016 UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS INFORMATION SHARING, BANK PENETRATION & TAX EVASION IN THE DEVELOPING COUNTRIES A thesis submitted in partial fulfillment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By VO MANH TAN Academic Supervisor Dr VO HONG DUC Ho Chi Minh City, November 2016 DECLARATION I hereby declare, that the thesis report entitled, “Information sharing, Bank penetration & Tax evasion in the developing countries” written and submitted by me in fulfillment of the requirements for the degree of Master of Art in Development Economics to the Vietnam – Netherlands Programme This is my original work and conclusions drawn are based on the material collected by me I further declare that this work has not been submitted to this or any other university for the award of any other degree, diploma or equivalent course HCMC, November 2016 Vo Manh Tan i ACKNOWLEDMENTS Immeasurable appreciation and deepest gratitude for the help and support are extended to the following persons who in one way or another have contributed in making this study possible Above all, I would like to express my special appreciation to my supervisor - Dr Võ Hồng Đức, for his supports, advices, guidance, valuable comments and suggestions It is an honor to work with him I would like to acknowledge all the lecturers and staffs at the Vietnam – Netherlands Programme for their useful knowledge and support during the time I studied at the program In specific, I am grateful to Prof Nguyễn Trọng Hoài, Dr Phạm Khánh Nam and Dr Trương Đăng Thụy, who guided me the first steps in the courses as well as in the thesis writing process I would like to thank my friends at Class 21 for their helps Last, but not least, I would like to thank family, my parents and my sister, who always love, take care of and support me unconditionally on the way I have chosen HCMC, November 2016 Vo Manh Tan ii ABBREVIATIONS TEI: Tax evasion index IRS: The U.S Internal Revenue Services GNP: Gross National Products GDP: Gross Domestic Products OECD: Organization for Economic Co-operation and Development DYMIMIC: Dynamic Multiple Indicators – Multiple Causes approach iii 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 iv 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 to 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 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 Key words: Tax evasion, Shadow economy, Information sharing, Bank penetration, Developing countries v TABLE OF CONTENTS DECLARATION i ACKNOWLEDMENTS ii ABBREVIATIONS iii ABSTRACT iv TABLE OF CONTENTS vi LIST OF FIGURES viii LIST OF TABLES viii Chapter 1: INTRODUCTION 1.1 Problem statement 1.2 Research objectives 1.3 Research questions 1.4 Contribution of the thesis 1.5 Structure of the thesis Chapter 2: LITERATURE REVIEW 2.1 Explaining tax evasion 2.1.1 Tax evasion approach 2.1.2 Tax evasion framework 2.1.3 Empirical evidence 12 2.1.4 Determinants of tax evasion 15 2.2 Connection with information sharing and bank penetration 18 2.2.1 Information sharing and bank penetration in financial system 18 2.2.2 Information sharing and Bank penetration role to tax evasion 19 Chapter 3: DATA AND METHODOLOGY 22 3.1 Methodology 22 3.1.1 New tax evasion index 22 3.1.2 Conceptual framework 23 3.1.3 Financial developments versus tax evasion 24 3.2 Data 26 vi Chapter 4: RESULTS AND DISCUSSIONS 32 4.1 The first hypothesis: Information sharing, bank penetration and tax evasion 32 4.2 The second hypothesis: Firm size and location influences 35 Chapter 5: CONCLUSIONS 39 5.1 Conclusions 39 5.2 Policy implications 41 5.3 Limitations 42 REFERENCES 43 Appendix A Definitions and sources of variables 48 Appendix B Data summary and list of industries 50 Appendix C Tax evasion index in the developing countries 51 vii LIST OF FIGURES FIGURE Conceptual framework of the thesis 24 FIGURE Tax evasion index in the developing countries, mean value from 2006 to 2014 51 LIST OF TABLES TABLE Tax evasion index by country in 2006 – 2014 28 TABLE Tobit regressions about effects of information sharing and bank penetration to tax evasion status 33 TABLE Tobit regressions about effects of firm size on the relationship between financial development variables and tax evasion status 36 TABLE Tobit regressions about effects of location on the relationship between financial development variables and tax evasion status 37 TABLE Data summary 50 TABLE List of industries 50 viii Small firms may not change their attitudes as their probability of being caught and additional cost is not high TABLE Tobit regressions about effects of location on the relationship between financial development variables and tax evasion status (1) VARIABLES Depth of info sharing (2) Tobit regressions (3) -0.00332*** (0.000618) 0.000749 (0.00118) 0.00317*** (0.00111) Depth of info sharing x Capital city Depth of info sharing x Small city Demographic bank penetration -0.000240** (0.000115) 0.000210 (0.000172) -0.000236 (0.000175) Demographic bank penetration x Capital city Demographic bank penetration x Small city Geographic bank penetration -2.91e-05*** (4.87e-06) 2.04e-05 (1.46e-05) 3.97e-05*** (8.58e-06) -0.0161*** (0.00388) 0.0209*** (0.00384) -0.00140*** (0.000476) 0.000241 (0.00145) 0.0130*** (0.00141) 27,803 Geographic bank penetration x Capital city Geographic bank penetration x Small city Small city -0.0217*** -0.000445 (0.00441) (0.00365) Capital city 0.0173*** 0.0217*** (0.00525) (0.00432) Ln(GDP per capita) -0.00254*** -0.00233*** (0.000482) (0.000456) Ln(Firm age) -0.00609*** -0.00186 (0.00149) (0.00142) Ln(Top manager’s experience) 0.00972*** 0.0124*** (0.00152) (0.00140) Observations 22,904 28,261 Robust standard errors in parentheses *** p