Italy: Eradicating tax evasion would benefit SMEs in particular

Added on 05/04/2017

Small, not very innovative, and tax evaders. The link between company size, innovative capacity and the quality of fiscal behavior is being put under the quantitative and non-moralistic spotlight of Emmanuele Bobbio, economist at the Bank of Italy, in his occasional paper “Tax evasion, company dynamics and growth,” reports Italy 24.

Bobbio has built a model that shows the current shape of Italy's industrial system and outlines the structure it would assume if there was no improper fiscal behavior, which causes a widespread and deep distortion of competition. The results highlight one of the sick roots of the tree -- which is increasingly becoming a bonsai -- of Italian productive capitalism: the reality is composed of small companies that tend to evade and avoid taxes.

The custom of dodging taxes makes it unhealthily useful to not grow, seeing that an increase in size implies greater monitoring on the part of authorities: those same companies do not expand and therefore they do not innovate, and at the same time, they do not innovate and therefore they do not grow.

And in this way the circle carries on, with the three elements – small size, unfairness toward the surrounding social and economic environment, and little formalized innovation – that feed off each other.

The analysis, carried out by the economic technique of calibration on the world of companies monitored by social security agency INPS, has significant results. The idea of a complete eradication of tax evasion – keeping all other tax burdens on companies equal (IRES, VAT, Irap and the tax wedge) – modifies the Italian industrial scenario in a radical way.

Using this model, the average company size index would rise from 1.62 to 2.03: the size would grow by a quarter.

The hypothetical innovation dynamic changes based on the size of the company: if all of a sudden you eradicated tax fiddling, in big companies the probability of generating an innovation in a year would rise from 6% to 7% per product line. In small companies that are already innovative, that probability would rise from 3.2% to 7%.

Therefore, in the first case it would not have a significant impact. In the second case, on the other hand, it would change everything. The innovative capacity of small companies would double.

Just as interesting is the rate of turnover – fundamental in a model of creation and creative destruction – of old styles of jobs replaced by positions generated by technological and organizational innovation: if currently that percentage is equal to 7.6%, in a model cleansed of tax evasion and avoidance that would rise to 8.5%.

That is almost one point higher. In general, in an Italy that is no longer Italy – therefore with appropriate fiscal behavior on the part of all companies – spending for innovation would rise from the current 2.58% of gross domestic product to 3.52%. The average size of companies would rise from 4.1 employees to 5.1. The share of added value produced by innovative companies would grow from the current 74.7% to 82.4%.

And there would finally be an improvement on the awful condition of “zero-something” growth: from a rate of annual GDP growth of 0.92%, Italy would move to 1.13%. National statistics office ISTAT has highlighted that in 2014, the unofficial and illegal economy was worth €211 billion, equal to 13% of GDP (12% made up of the unofficial economy and 1% made up of illegal activities).

In such a complex context, it becomes important to try to understand the dynamic elements that undergo a chaotic development, depressed by the recession and often suspended between a push toward growth and the border-line.

In the case of big companies, using Bobbio’s model at constant evasion rates and falling fiscal pressure, the probability of generating an innovation in one year, per product line, remains just about identical to the current reality: around 6%. The reaction to a fall in taxes on the part of small companies (those already capable of innovation) is different, whose probability of creating innovation in the subsequent year – now around 3% - rises to up to 4.1% in the case that the lever used is the reduction of IRES corresponding to 1 point of fiscal pressure.

Size and innovative capacity, tendency to respect the law or not and policy: a hypothetical -- and hoped for -- Italian economic recovery can only be achieved by these virtuous interactions between all these elements.