SME tax avoidance in the presence of informal competition from shadow economy

Using the data for Indian SMEs, this paper examines in an emerging market setting whether firms with exposure to informal competition are more likely to avoid taxes. We use a sample of 9281 Indian firms that responded to the World Bank Enterprise Survey and find empirical evidence that supports this conjecture. We find that firms headquartered in states/provinces with better business environment and firms with more competitive position in the market are less likely to avoid taxes in response to informal competition. This paper also shows that firms that avoid taxes are more likely to invest in innovation and have more efficient operations than the firm that does not avoid taxes.