revenue hiding in part or full in return for a promise to leave behind a portion of unhidden
production.
However, more must be left behind for firms which find it easier to hide,
potentially reducing the return to the ruler of providing support. This will not be the case
only under a pair of conditions that leave the ruler the residual claimant on any production
resulting from state support: the ruler must be able to commit to a particular lump-sum
tax that provides the firm with an incentive to not hide, and the productivity of hidden
production in the “informal sector” must be unaffected by state support. It is likely that
these two conditions are not simultaneously met in real-world institutional settings.
With the exception of this limiting case, the models presented below suggest that social-
contract failures will be present even in institutional environments in which states have
invested in their credibility. Beyond this basic result, however, the models vary widely in
their predictions about the nature of revenue hiding and provision of state support.
In
particular, ruler and firm will fall farthest short of the Pareto frontier when the ruler is
unable to commit to leaving the firm with a portion of its production.
Empirically, we
are therefore interested in knowing not only whether state support is indeed related to the
taxability of economic activity, as the models presented below generally predict, but also
whether that bias arises in a context of state commitment or noncommitment.
These questions are explored in the analysis of data from a survey of firms in 25 post-
communist states.
As discussed below, postcommunist countries are a particularly apt
environment in which to explore the impact of taxability on state support of economic activ-
6
Convention