Who Tolls the Bells for Firms? Tales from Transition Economies

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Bankruptcy law is regarded as an important mechanism for protecting creditor rights. Much of the current debate about bankruptcy law focuses exclusively on private creditors, ignoring the role of tax authorities as creditor in insolvent firms. Based on data from several transition economies, this essay documents the important, if not dominant, role tax authorities play as initiator of bankruptcy in these countries. While improved tax enforcement is crucial for tackling the problem of tax arrears and hardening the “soft budget-constraint” in former socialist countries, this essay suggests that the presence of the tax authorities as creditor may also affect the cost of debt financing and may have contributed to the difficulties firms in these countries continue to have in obtaining longer term debt finance. This is the case in particular when the tax authorities shift from a low to a high enforcement regime in an environment where firms had already accumulated substantial tax arrears in the past, making the tax authorities senior creditors in bankruptcy. This essay follows Desai et al. in asking for more attention to be paid to the tax authorities as stakeholders in firms. Contrary to Desai et al., however, the paper suggests that the role of the tax authorities cannot be limited to that of a minority shareholder, but is more adequately described as “convertible-equity” holder.