Tax Avoidance and the Allocation of Credit

Abstract

This paper models the credit-seeking behavior of a firm when applying for a bank loan increases the probability of being monitored by the fiscal authorities. Using Russia as an example of an economy with poorly enforced tax payment, I find that if the probability of paying taxes increases as a result of applying for a bank loan, profit maximizing firms will be less likely to borrow at a given rate of interest. In addition, firms with less risky projects will be more likely to drop out of the borrower pool. Finally, the more profitable a firm has been in the past, as measured by the return to its existing investments, the less likely it will be to borrow from a bank to finance a new investment project. In an economy where alternative forms of external capital are few, this disincentive to borrow has significant consequences for the overall level and quality of investment in the economy