Corruption as an informal fiscal system

Abstract

Persistent corruption and limited fiscal capacity often go hand-in-hand. We explore one reason why governments may fail to address both issues: the possibility that corruption supports an informal, parallel fiscal system. We document that in settings with low state capacity and resources, governments implicitly expect lower-level officials to extract rents from citizens in order to fund the delivery of public goods and services. Using survey data and government accounts in Pakistan and India, we show that public officials use personal funds to complement official funding for public services, and that part of these funds come from bribes. We propose a model of bureaucratic agency to explore when governments benefit from sustaining such systems and investigate welfare implications. Informal fiscal systems are more likely to arise when monitoring corruption is costly relative to monitoring the provision of public services, and politically-important groups of citizens do not bear the full cost of corruption.