draining development.pdf - Khazar University

The Political Economy of Controlling Tax Evasion and Illicit Flows 77flows (Schneider, A. 2007; UNECA 2009). The dynamics of petty evasionalso have political implications, however, because of what Tendler (2002)refers to as the “devil’s deal,” the tacit understanding in patronage politicsthat petty tax evasion (evasion that does not lead to significant illicitflows) is tolerated as the quid pro quo for political support that allowsgrand evasion and illicit flows: “if you vote for me . . . , I won’t collecttaxes from you; I won’t make you comply with other tax, environmentalor labor regulations; and I will keep the police and inspectors fromharassing you” (Tendler 2002, 28). This leaves both vested interests andthe informal economy untaxed or undertaxed and deprives the informalsector of the incentive to engage in constructive political bargainingover taxation, the fiscal social contract. 16 At the same time, rulers are leftunrestrained to embezzle and misuse public resources to sustain theirgrip on power, while the public goods and services necessary for povertyreduction and development are underprovided.This devil’s deal underpins the neo-patrimonial politics behind illicitcapital flows. Political clients do not act as taxpaying citizens using theirvotes to improve governance, and political patrons exploit corruptionand tax evasion to fund their grip on power, while protecting their longtermprospects outside the country. So, political dynamics shape thecapacity of the state to manage evasion and constrain the incentives forpolitical and economic elites to shift the tax burden to middle-size firmsand the middle class. 17The Political Economy of Tax EvasionThe dynamics outlined above indicate that the political economic determinantsof the extent of tax evasion in any specific context reflect a combinationof six factors, as follows: (1) the structure of the economy thatshapes the potential sources of government revenues; (2) the structureof the political system, that is, the political rules by which politiciansgain and hold onto the power that shapes political competition andincentives (constitutions, party structures, electoral processes, legislativeand executive rules shaping policy choice, and so on) (Stewart 2007;Schneider, F. 2007); (3) the state’s monopoly of violence as the basis forenforcing state tax and other authority (North et al. 2007; North, Wallis,and Weingast 2009); (4) the credibility of the regime’s political time