Bribes vs. Taxes: Market Structure and Incentives∗

Firms in developing countries often avoid paying taxes by making informal payments to business tax inspectors. These bribes increase 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. The scheme increases the bargaining power of firms in their relationship with tax officials and decreases the bribe size. In our model, firm heterogeneity shapes the interaction between firms and inspectors and the equilibrium bribery outcome. Feedback incentives both make firms with larger pass-through more attractive for inspectors. A tilted incentive scheme that attaches higher weights to the evaluation of smaller firms decreases targeting along this margin while decreasing the bribe size. We evaluate both schemes in a field experiment in Kyrgyzstan, 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 less firms substitute bribes for taxes, tax revenues increase. Our study highlights the role of firm heterogeneity and market structure in shaping the trade-off faced by firms and tax inspectors and provides clear evidence of pass-through of bribes to consumers.