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This paper presents evidence of market externalities of tax evasion: firms’ tax
non-compliance distorts the outcomes of their competitors. Using novel administrative
data on Italian firms, we estimate tax evasion through firms’ manipulation
of revenue to access preferential tax regimes. Our empirical approach uses policyinduced
changes in tax notches’ size to predict the fraction of non-compliant firms
in each market. We find that non-compliant firms lead to significant revenue and
productivity losses for their competitors, who then pass on some of this burden to
their workers. This unfair competition harms aggregate productivity, partly due to a
worsening of allocative efficiency.
