Value-Added Taxes, Chain Effects, and Informality

Abstract

We present an equilibrium model of tax avoidance and test its implications using a survey of firms in Brazil. In the model, the credit method used to collect value-added tax (VAT) creates informality chains-clients or suppliers of informal firms are more likely to be informal. An increase in enforcement in a production stage increases formality downstream and upstream. Various empirical measures of formality of suppliers and buyers, and of enforcement downstream and upstream, are positively correlated with formality. When the VAT is applied in a single stage of production at a rate estimated by the authorities, these chain effects disappear. (JEL H25, H26, L14, L21, O14, O17)

The Extent and Determinants of Tax Gap in the Informal Sector: Evidence from Ghana

“…However, only a few studies have employed the micro approach in developing countries, partly due to the lack of data and complexity of analysis. (Slemrod & Yitzhaki, ; De Paula & Scheinkman, ; La Porta & Shleifer, ).…”

Value‐Added Tax, Input–Output Linkages and Informality

“…Next, I add VAT to this structure and model formal and informal sectors, which are different in tax compliance and productivity. Similar to De Paula and Scheinkman (), it turns out that VAT results in an assortative matching equilibrium, in the sense that (in)formal firms tend to trade with (in)formal businesses and not the other type. The theoretical analysis then suggests that the formality of an activity is positively associated with its forward linkages.…”

“…At a more specific level, this paper also speaks to the literature that studies the network effects of a commodity tax in one activity on the informality of other activities (De Paula and Scheinkman ; Pomeranz ). Finally, this paper contributes to the literature modelling informality as a trade‐off between tax evasion and access to productivity‐enhancing public goods (Straub ; Gordon and Li ; D’Erasmo and Moscoso Boedo ; Capasso and Jappelli ) and is the first one to model it on an input–output structure.…”

“…De Paula and Scheinkman () show that the input refund feature of VAT results in an assortative matching equilibrium in the sense that formal and informal firms trade only with the same type. Let and be the formal and informal prices of product n .…”

“…The theoretical contribution of this paper is to formalize the self‐enforcing feature of VAT. To my knowledge, the theory most pertinent to this is presented by De Paula and Scheinkman (), who model the informal sector on the presence of VAT. They, however, do not discuss the role of linkages between activities on formality transmission and optimal enforcement.…”