Corruption is found to be more damaging than taxation by recent micro studies coming out of the World Bank (Cai et al. 2011; Fisman and Svensson 2007).<sup>15</sup> By exploiting a Ugandan firm data set containing information on the estimated bribe payment, Fisman and Svensson (2007) study whether taxes or corruption is more damaging for firm growth. Recognizing that the bribe rate (i.e., bribes over sales) is potentially endogenous, they instrument it with its industry-location average. This approach will correctly obtain the causal effects of corruption when the industry-location average of the bribe rate does not directly affect firm growth (other than just via firm bribe rates)— likely when there are no other (i.e., uncontrolled) industry-location-specific variables that directly affect firm growth. They find that both are negatively correlated with firm growth. A 1 percentage point increase in the bribe rate is associated with a reduction in firm growth of 3 percentage points, an effect about three times greater than that of taxation in their sample.

Evidence from China—a country featuring both spectacular growth and rampant corruption—also suggests that corruption tends to be quite damaging on average. Cai et al. (2011) use a large sample of Chinese firms to examine the effects of corruption on firm performance. Since Chinese firms tend to vastly under-report bribes in surveys (based on personal observations of this author in the investment climate survey process), the paper adopts an idea proposed by a local official acquaintance to use the entertainment and traveling costs (ETCs) of firms as a proxy of corruption. Indeed, they find that ETCs are a good proxy for corruption: they are higher where you expect them to be higher (e.g., when government services are poor so you have to bribe for services as grease payment) and when tax burdens are high (so you can reduce the tax burden and enforcements through bribes). Using city-industry median ETCs as the instrument for firm-level ETC, they find that ETCs on average have significantly negative effects on firm productivity, yet official effective tax rates (i.e., total tax payments over sales) are not, on average, significantly related to productivity. The estimated effect of ETC is causal if the city-industry median ETC does not directly affect productivity (other than through firm-level ETCs). Interestingly, the negative effects of ETCs are less pronounced and can completely disappear in locations featuring particularly high tax burdens and bad government services. So there are private returns to firms in bribing governments, especially

> 15Corporate tax rates are found to have a strong negative association with aggregate economic outcomes based on cross country data (Djankov et al. 2009). After collecting new data on effective corporate income tax based on a standardized firm for 85 countries and relying on cross-country cross-sectional regressions, Djankov and his colleagues find that the effective corporate tax rate is negatively correlated with aggregate investment, foreign direct investment, and entrepreneurial activities and positively correlated with the share of informal sector in the economy. The magnitude is nontrivial. Increasing the effective corporate tax rate by 1 percentage points is associated with reducing the aggregate investment to the gross domestic product (GDP) ratio by 0.2 percentage points (the mean is 21 percent) and the official entry rate by 0.14 percentage points (the mean is 8 percent).

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