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The effect of taxation and corruption on firm growth: An empirical investigation for Vietnam

The effect of taxation and corruption on firm growth: An empirical investigation for Vietnam. The aim of this study is to analyze empirically the impact of taxation and corruption on the growth of manufacturing firms in Vietnam. The study employed pooled OLS estimation and then instrument variables with fixed effect for the panel data of 1377 firms in Vietnam from 2005 to 2011.



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Journal of Economics and Development, Vol.18, No.3, December 2016, pp. 5-29

ISSN 1859 0020

The Effect of Taxation and Corruption
on Firm Growth: An Empirical
Investigation for Vietnam
Le Thi Ngoc Bich
Post and Telecommunication Institute of Technology, Vietnam
Email: bichltn@ptit.edu.vn

Abstract
The aim of this study is to analyze empirically the impact of taxation and corruption on the
growth of manufacturing firms in Vietnam. The study employed pooled OLS estimation and then
instrument variables with fixed effect for the panel data of 1377 firms in Vietnam from 2005 to
2011. These data were obtained from the survey of the Central Institute for Economic Management
and the Danish International Development Agency. The results show that both taxation and
corruption are negatively associated with firm growth measured by firm sales adjusted according
to the GDP deflator. A one-percentage point increase in the bribery rate is linked with a reduction
of 16,883 percentage points in firm revenue, over four and a half times bigger than the effect of
a one-percentage point increase in the tax rate. From the findings of this research, the author
recommends the Vietnam government to lessen taxation on firms and that there should be an
urgent revolution in anti-corruption policies as well as bureaucratic improvement in Vietnam.
Keywords: Bribery rate; corruption; instrument variable; fixed–effect method; panel data;
small and medium enterprises; taxation; Vietnamese firms.

Journal of Economics and Development

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Vol. 18, No.3, December 2016

1. Introduction

in turn, will create growth and employment.
Moreover, Vietnam has had to face fierce global competition after joining the World Trade
Organization (WTO) in 2007, so this change in
taxation can promote competitiveness and exports of Vietnamese firms by lessening their financial burden. Especially, this financial relief
is necessary for small and medium enterprises
(SMEs) that account for over 90% of the number of operating enterprises in Vietnam (General Statistics Office of Vietnam, 2010) since
financial deficiency is their big obstacle. However, many experts suspect the efficiency of
this policy arguing that tax cuts are not always
accompanied with firm growth and investment
expansion because the tax burden is only one
of the obstacles faced by Vietnamese firms
(World Bank, 2015). These experts posit that
this matter should be analyzed with the provision of more empirical evidence rather than by
assumption.

Corruption has been a serious matter in
Vietnam which can be seen and felt in daily
activities, in hospitals, in schools or businesses. According to Corruption Perceptions Index
provided by Transparency International (20052014), Vietnam has been making progress in
reducing corruption, with the upgrade of the
corruption perception index (CPI) from 2.6 in
2005 to 3.1 in 2014 (Appendix B). Nevertheless, these improvements seem to be insufficient when Vietnam is still amongst countries
facing the most serious bribery problems. Vietnam lags behind other Asian countries, and the
impact of corruption on the Vietnamese economy is still ambiguous with a lack of scientific
studies for proper analysis and evaluation.
Similarly, taxation, precisely corporate income tax (CIT), has been recently an economic
concern for firms in Vietnam. Following the decreasing trend of the tax rate in neighbor countries, the Vietnam government has reduced corporate income tax in an attempt to improve the
competitiveness of domestic companies.Vietnam has implemented three important phases
of tax reforms, which have been assessed to
have substantial impacts on socio-economic
development (IMF, 2012). Accordingly, the tax
reform of 2006-2010 with numerous amendments and supplements in legislation contributed significantly to the process of economic
reform. The CIT rate was reduced from 28% to
25% from January, 1st 2009 and to 20% from
January, 1st 2014. Furthermore, it is suggested that the CIT will reduce more in following
years (Appendix C). A number of supporters
of this policy believe that the tax cut will encourage firms to invest more, attract FDI, and
Journal of Economics and Development

Given the controversy on the effects of taxation and bribery, the major objective of this
study is to measure simultaneously the effects
of tax and bureaucratic problems on the Vietnamese economy, with corruption being the
variable for illustrating bureaucratic matters.
One reason to put taxation together with bribery in this study is that both are considered by
authorities as costs or financial barriers for firm
growth. The findings in this study will make
clear the matters on which the burden of official
or unofficial payments should be focused when
dealing with policies to improve the business
environment in Vietnam. By using micro-level
evidence, the findings of this study are likely to
highlight more accurate and practical messages
on these issues as firms are fundamental ele6

Vol. 18, No.3, December 2016

ments in the economy as well as being affected
directly by changes in taxation and bribery.

peting hypotheses, namely “sand the wheels”
and “grease the wheels” (Méon and Sekkat,
2005). The core of the debate between these
two points of view is based on the combination
of corruption and a low quality of governance.
Numerous support arguments for the “grease
the wheels” hypothesis suggest that corruption can have a positive impact on economic
growth. These arguments circulate the idea that
the ill-functioning of the bureaucracy is considered the most popular inefficiency for which
corruption can compensate in various aspects.
One concern of inefficient bureaucracy is the
slowness in process. Lui (1985) suggestes that
bribes can be the motivation for government
officials to speed up the process and efficiently lessen unnecessary waiting time. Another
problem of ill-functioning bureaucracy is the
poor quality of civil servants. Leys (1964) and
Bailey (1966) argue that this problem can be
solved by the existence of corruption. With insufficient wages, the government service sector
can hardly attract competent bureaucrats. However, when perks play a role as a complement to
their income, they may be willing to work for
state units, and the quality of civil servants is
improved. Finally, Beck and Maher (1986) and
Lien (1986) show that bribery may be a tool for
government officials to make proper decisions,
especially when they do not have enough information or competency to make right judgements about a firm’s capacity. For example,
in systems where firms have to pay bribes to
get licenses, permits or government contracts,
bribery can play a role as an efficient process
for civil servants to distribute limited resources
to more generous bribers who can be more efficient at the same time.

In terms of methodology, this paper will
employ the analysis framework suggested in
Fisman and Svensson (2007) for Uganda firms.
Their paper was outstanding for its methodology and persuasive findings. One advantage
of our paper compared with previous studies,
including the one of Fisman and Svensson
(2007), is that the informative panel data from
2005 to 2011 on SMEs in Vietnam will be employed with a bigger sample size and longer
duration of observation. It means characteristics of a larger number of firms are observed
not only in one year, but also in four years, allowing specific techniques of panel data to be
applied in estimation to eliminate econometric
problems for more robust and unbiased results.
The rest of the paper is structured as follows.
Section 2 reviews the literature on corruption
and taxation. Section 3 describes the methodology for the study. Section 4 presents the findings and discussion of the results, and Section
5 gives policy implications and a conclusion.
2. Literature review
The effects of corruption and taxation on
economic growth have been controversial issues in both theoretical and empirical perspectives, with different hypotheses and empirical
researches revealing various findings.This section is an overview of important theories and
empirical outcomes which have been mentioned in the literature.
2.1. Review of theoretical arguments/models
Concerning the impact of corruption on economic growth, there are two prominent comJournal of Economics and Development

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Vol. 18, No.3, December 2016

proposes the classification of corrupt behaviors
according to their effects on economic growth.
Broadly speaking, corrupt actions can be divided into two types with opposite impacts
on economic growth: economically restrictive
corruption and economically expansionary corruption. The existence of these types may be
subject to the impact of corruption on the possibility of free exchange in an economy. Specifically, he argued that regulation in countries
is usually a restrictive force on free exchange,
which is crucial for economic growth. If corruption is used as a tool for enterprises to avoid
those legal barriers and enhance competitive
exchange, then corruption will be an expansionary element in the economy. By contrast,
corruption is restrictive if it limits chances for
beneficial fee exchange and impedes wealth
creation.

The “sand the wheels” hypothesis, meanwhile, is the formal statement of the common
sense that corruption is detrimental to economic activities. Many theoretical arguments have
been revealed to support this conventional
viewpoint. Against the argument that an official can speed up the slow bureaucratic process
dueto bribery, Myrdal (1968) argues that it is
not true in many cases because corrupt officials
may also cause unnecessary delays to get more
chances for extracting a bribe, which adversely impacts economic activities. The study of
Murphy et al. (1991) speculates that bribery is
harmful at an aggregate level because it distorts
economic incentives, hinders investment and
allocates talented people to rent-seeking activities. Furthermore, Kurer (1993) argues that the
idea on the improvement in quality of bureaucrats due to corruption is a debatable subject.
To preserve their illegal income source, corrupt
bureaucrats can cause some distortions in the
economy and also have the incentive to prevent new officials’ access (especially talented
ones) to important positions in government service. Similarly, the notion that corruption can
enhance the possibility of bureaucrats making
right decisions is questionable. The association
between the ability to pay a high bribe and the
high efficiency of bribers is not always true.
Mankiw and Whinston (1986) show that permission can be beneficial for firms but disadvantageous for social welfare. These firms pay
high bribes to get authorization or permission
to enter the market because they find it profitable, while for social welfare their entrance is
damaging. In these cases, bribery may not play
as an efficient tool for officials’ decisions.

Concerning theories on taxation, Wanniski
(1978) proposes that tax instruments can be
used to stimulate economic growth. Accordingly, tax cuts probably improve the incentives of
people to work and save more to increase their
income, and this, in turn, will become capital
resources to boost investment and economic
growth (Gale and Samwick, 2016). This opinion seems to coincide with the tax policy of
many countries recently, especially in corporate
income tax (CIT). The IMF (2012) showes that
CIT rates have been fallen gradually in both
low-income and high-income countries in order to attract investment, improve competitiveness of domestic firms and the internationally
competitive CIT rate currently stands at around
25%. Not only the tax rate, but the range of
CIT incentives also continues to be more generous and less complex. For the Asian region,

Taking both points of view, Osterfeld (1992)
Journal of Economics and Development

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Vol. 18, No.3, December 2016

and macroeconomic-level data. The study of
Mauro (1995), that made use of country-level
data consisting of subjective indices of bureaucratic honesty and efficiency, gives empirical
evidence on the association between corruption and the economy. His study supports the
hypothesis that corruption limits economic
growth, impedes investment and negatively
changes the government spending structure.
The negative relationship between corruption and investment, as well as corruption and
growth, found in the paper are robust and significant in both economic and statistic senses.
Mo (2001) investigated the role of corruption
in economic growth and its transmission channels using the quantitative method. The study
finds that a one percentage point increase in the
bribery level reduces the growth rate by about
0.72 percentage points. Likewise, the study of
Gyimah-Brempong (2001) on the panel data
from African countries indicates that corruption
decreases economic growth directly through
an indirect negative impact on investment in
physical capital. Quantitatively, a unit increase
in corruption is supposed to be associated with
a from 0.75 to 0.9 percentage point reduction in
the growth rate of GDP and between 0.39 and
0.41 percentage point reduction in per capita
income. The study also implies that corruption
affects adversely income equality or put differently, the poor in African countries areaffected
more negatively than the rich.

the average CIT rate in 2011 was 22.78% and
it is predicted to reduce more in future years
(KPMG International, 2011). However, many
argue that the impact of tax cuts on growth is
uncertain and complicated, depending on other
factors such as the structure of tax, the timing
and the state budget. Tax cut competition is
likely to be a good condition for multinational firms to transfer price by shifting their profit
from high-tax countries to low-tax countries,
which is definitely unwanted by governments.
Additionally, countries may have to face a federal budget deficit if tax cuts are not accompanied with spending cuts and the expansion
of production, which subsequently reduces
national savings and raises interest rates in the
long term. Moreover, the income effect should
be taken into account if income is increased by
tax cuts and is probably the reason households
lose their motivation to work and for firms to
invest in new technology (Gale and Samwick,
2014). Overall, tax policy is still a controversial issue in many countries, with various arguments about its effects.
About the simultaneous effects of bribery
and taxation on growth, it is commonly said
that bribes are quite similar to tax from a firms’
perspective because both can be counted as
costs. The main difference is that tax is going
to become public revenue while bribes will not.
However, Schleifer and Vishny (1993) insist
that due to uncertainty, high transaction costs
and the secrecy of bribery are likely to be more
devastating to firm growth than taxation.

On the other hand, the research in Latin
America, Sub-Saharan Africa and Transition
Countries written by Asiedu and Freeman
(2007) provided more complicated empirical
evidence about the relationship between investment and corruption at a firm and country level.

2.2. Review of empirical studies
To give practical evidence on the role of
corruption, many empirical studies have been
implemented, using both microeconomic-level
Journal of Economics and Development

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Vol. 18, No.3, December 2016

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