DP13055 Bribes vs. Taxes: Market Structure and Incentives
Firms in developing countries often avoid paying taxes by making informal payments to
tax officials. These bribes may raise the cost of operating a business, and the price charged
to consumers. To decrease these costs, we designed a feedback incentive scheme for business
tax inspectors that rewards them according to the anonymous evaluation submitted by
inspected firms. We show theoretically that feedback incentives decrease the equilibrium
bribe amount, but make firms with more inelastic demand more attractive for inspectors.
A tilted scheme that attaches higher weights to the evaluation of smaller firms limits the
scope for targeting and decreases the bribe amount to a lesser extent. We evaluate both
schemes in a field experiment in the Kyrgyz Republic and find evidence that is consistent
with the model predictions. By decreasing bribes, our intervention reduces the average
cost for firms and the price they charge to consumers. Since fewer firms substitute bribes
for taxes, tax revenues increase. Our study highlights the role of firm heterogeneity and
market structure in shaping the relationship between firms and tax inspectors, and provides
clear evidence of pass-through of bribes to consumers.