Extract
Taxation by state and organized crime: harmony or conflict?
Abstract
Organized crime has played an important role in several economies in transition, where the state has been either unwilling or unable to fulfill some of its important functions. In particular, the mafia has taxed the producers and provided such services as protection and contract enforcement. Typically, the analytical literature has assumed that the mafia operates only in the unofficial economy. We drop this assumption and examine the previously unexplored implications of the mafia's taxation of legal economic activity and particularly the effect this has on the revenue-maximizing government's tax policy and its incentive to combat the mafia. Our main result is that as long as the demand for the firms' output is inelastic and if the mafia is not too strong, as measured by how costly it is for the mafia to tax official sales, its taxation of legitimate economic activities does not affect the revenue-raising capacity of the state. However, if the demand is elastic, an increase in the mafia's strength always hurts the state. In addition, we investigate the official tax policy consequences of the change in the firms' costs of operating underground, the government auditing of firms, and the implications of welfare optimization by the state. Journal of Economic Literature Classification Codes: H26, H21, and P51 Keywords: Optimal taxation, tax evasion, organized crime TAXATION AND EXTORTION BYORGANIZED CRIME: HARMONY OR CONFLICT? 1. INTRODUCTION Organized crime has apparently played an important role in several economies in transition, where the state has been either unwilling or unable to fulfill some of its important functions. Organized crime groups, which we will call the mafia, have been extorting regular payments from firms, usually, but not always, in return for protection and some enforcement of property rights. (3) This phenomenon has been modeled in the recent literature that emphasizes the role of the mafia as an alternative "tax collector" and a provider of public goods that facilitate firms' underground activities. (4) Despite the apparent competition between the state and the mafia for the tax revenues, in some countries the state has not been particularly eager to fight the mafia. Alexeev et al. (2002) argued that the mafia's presence can actually benefit the revenue-maximizing government, as long as public goods do not play a significant role in determining whether the firms operate officially or underground. However, the earlier theoretical literature has assumed that the mafia taxed only illegal activity, ...See the full content of this document
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