Maintain Self-Enforcement Characteristics
The VAT in Practice: Equity, Enforcement, and Complexity
Abstract: The value-added tax (VAT) is meant to be an efficient and self-enforcing tax on consumption. Yet, being a rather sophisticated tax, the VAT can also be complex and costly to administer. By examining the case of Rwanda, this paper assesses the extent to which the VAT’s potential materialises in the context of a lower-income countries. Using a mixed-methods approach, which combines qualitative information from focus group discussions with the analysis of administrative and survey data, this paper makes two contributions. First, it documents reporting inconsistencies in VAT data, providing new evidence on how weak capacity prevents tax administrations in lower-income countries from reaping the full benefits of the VAT. Second, it shows that the VAT, as applied in practice, differs substantially from its theoretical functioning. This generates differences in tax burdens across firms, despite a proportional tax rate, with important distributional implications. We also document that the VAT chain often breaks down, with implications on the VAT’s efficiency.
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Citation: Mascagni, Giulia, Roel Dom, Fabrizio Santoro, and Denis Mukama. “The VAT in Practice: Equity, Enforcement, and Complexity.” International Tax and Public Finance 30, no. 2 (2023): 525–63. https://doi.org/10.1007/s10797-022-09743-z.
No Taxation Without Information: Deterrence and Self-Enforcement in the Value Added Tax
Abstract: Claims that the VAT facilitates tax enforcement by generating paper trails on transactions between firms contributed to widespread VAT adoption worldwide, but there is surprisingly little evidence. This paper analyzes the role of third-party information for VAT enforcement through two randomized experiments among over 400,000 Chilean firms. Announcing additional monitoring has less impact on transactions that are subject to a paper trail, indicating the paper trail's preventive deterrence effect. This leads to strong enforcement spillovers up the VAT chain. These findings confirm that when taking evasion into account, significant differences emerge between otherwise equivalent forms of taxation.
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Citation: Pomeranz, Dina. “No Taxation without Information: Deterrence and Self-Enforcement in the Value Added Tax.” American Economic Review 105, no. 8 (2015): 2539–69. https://doi.org/10.1257/aer.20130393.
VAT, Tariffs, and Withholding: Border Taxes and Informality in Developing Countries
Abstract: This paper explores the implications of a distinctive feature of the value added tax (VAT) that is stressed by practitioners but has been largely overlooked by theorists: that it functions, in part, as a tax on the purchases of informal operators from formal sector businesses and, not least, on their imports. It also stresses the potential importance of the withholding taxes that are levied by many developing countries — which have also been ignored. It is shown, in a simple model of informality, that if both of these instruments are optimally deployed then the usual prescription that a small economy should not deploy tariffs remains valid even in the presence of an informal sector; and a simple strategy is established — generalizing the standard prescription developed in models without informality — for deploying these instruments so as to preserve government revenue and increase welfare in the face of efficiency-improving tariff cuts. Conditions are established under which a VAT alone is fully optimal, precisely because it is in part a tax on informal sector production. But they are restrictive: in general, an efficient tax structure requires deploying both a VAT and withholding taxes.
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Citation: Keen, Michael. “VAT, Tariffs, and Withholding: Border Taxes and Informality in Developing Countries.” Journal of Public Economics 92, nos. 10–11 (2008): 1892–906. https://doi.org/10.1016/j.jpubeco.2008.05.006.