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.JEL codes: H26, H25, O17, O38 * I thank Alberto Alesina, Samuel Asher, Martin Besfamille, Lorenzo Casaburi, Raj Chetty, David Cutler, Oeindrila Dube, Martin Feldstein, Brigham Frandsen, Edward Glaeser, Dominik Hangartner, Lakshmi Iyer, Kelsey Jack, Matthew Gentzkow, Louis Kaplow, Felipe Kast, Lawrence Katz, Henrik Kleven, Wojciech Kopczuk, Michael Kremer, Josh Lerner, Jeffrey Liebman, Stephan Litschig, Isaac Mbiti, Stephan Meier, Sendhil Mullainathan, Paul Niehaus, Suresh Naidu, Giacomo Ponzetto, Joel Slemrod, Matthew Weinzierl, Justin Wolfers, Danny Yagan, Tristan Zajonc, participants at various seminars and conferences, and three anonymous referees for helpful comments. I am exceedingly grateful to the Chilean Tax Authority for outstanding collaboration and funding of the implementation and to the Swiss Study Foundation, the David Rockefeller Center for Latin American Studies, and the Project on Justice Welfare and Economics for research and travel grants that made this project possible.† Harvard Business School, Boston, MA, 02163; dpomeranz@hbs.edu. (617) 495-1422. 1A fundamental constraint for taxation is that governments need to be able to observe transactions in order to impose a tax on them. A growing literature therefore argues that understanding information flows is central to effective taxation. When governments imperfectly observe transactions, important differences emerge between forms of taxation that are equivalent in standard models of taxation but differ in the information they generate for the government (Slemrod, 2008).1 Third-party reporting, verifiable paper trails, and whistleblowers are thought to play an important role in facilitating tax enforcement (Kopczuk and Slemrod, 2006; Kleven et al., 2009 Kleven et al., , 2011 Kumler et al., 2013). The challenge of enforcing taxation is particularly severe in developing countries, where many transactions in the economy are not readily observable by the government, and it has been argued that these limited sources of information can explain some of the key differences in tax systems between developed and developing countries (Gordon and Li, 2009; Besley and Persson, 2012). 2The Value Added Tax (VAT) is a stark example of a tax believed to facilitate enforcement through a built-in incentive structure that generates a third-party reported paper trail...

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