We develop a framework for nonparametrically identifying optimization frictions and structural elasticities using notches—discontinuities in the choice sets of agents—introduced by tax and transfer ...policies. Notches create excess bunching on the low-tax side and missing mass on the high-tax side of a cutoff, and they are often associated with a region of strictly dominated choice that would have zero mass in a frictionless world. By combining excess bunching (observed response attenuated by frictions) with missing mass in the dominated region (frictions), it is possible to uncover the structural elasticity that would govern behavior in the absence of frictions and arguably capture long-run behavior. We apply our framework to tax notches in Pakistan using rich administrative data. While observed bunching is large and sharp, optimization frictions are also very large as the majority of taxpayers in dominated ranges are unresponsive to tax incentives. The combination of large observed bunching and large frictions implies that the frictionless behavioral response to notches is extremely large, but the underlying structural elasticity driving this response is nevertheless modest. This highlights the inefficiency of notches: by creating extremely strong price distortions, they induce large behavioral responses even when structural elasticities are small.
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BFBNIB, INZLJ, IZUM, KILJ, NMLJ, NUK, PILJ, PNG, SAZU, UL, UM, UPUK, ZRSKP
This paper examines firm behavior to taxation in a low enforcement and large informality setting. Using quasi-experimental variation created by a tax reform, which increased taxation of partnerships ...substantially relative to firms of other legal form, and the population of income tax returns filed in Pakistan in 2006–11, I document that treated firms report significantly lower earnings, migrate into informality, and switch business form in response to the increase in tax rate. The revenue loss caused by these behavioral responses is so large that by the third year after the reform the government was collecting less revenue than it would have without the tax increase. This implies that the new tax rate was on the wrong side of the Laffer curve and would not have been optimal under any social preferences. The richness of the data and tax variation permits me to decompose the observed responses into real and evasion margins and to identify fiscal externalities created by the reform on other tax bases. The welfare cost of the reform increases by around 40% once these externalities are taken into account.
•Examine firm behavior to taxation in low tax capacity setting•Find that firms when facing higher taxation increase tax evasion, exit into informality, and shift legal form•Behavioral responses so large, the tax increase caused a decrease in total revenue.•The new tax rate was above the Laffer bound.•Also estimate fiscal externality on other tax bases.
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GEOZS, IJS, IMTLJ, KILJ, KISLJ, NLZOH, NUK, OILJ, PNG, SAZU, SBCE, SBJE, UL, UM, UPCLJ, UPUK, ZRSKP
I leverage the staggered rollout of VAT in Pakistan to document the role of withholding mechanism in the self-enforcement of a VAT. Focusing on firms already in the tax net, I see how their outcomes ...respond when the tax is extended upward to intermediates used by them. I find that the upward extension of VAT, which triggers the withholding mechanism, causes an immediate and large (more than 40 log points) surge in sales reported by firms. The evolution of bunching above the zero-liability point and of input costs reported by firms suggests that this large response is indeed driven by the withholding mechanism. I also explore the role of withholding in the extensive margin compliance choices of firms.
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CEKLJ, IZUM, KILJ, NUK, PILJ, SAZU, UL, UM, UPUK
Value-added tax has seen phenomenal expansion in recent decades. Its appeal in part lies in its robustness to tax evasion relative to other tax instruments. Exploiting a tax reform from Pakistan that ...cuts the tax rate on five major industries of the country substantially, I estimate the size and nature of VAT evasion in the treated industries, finding that it ranges from 31–46% of the potential revenue. One important channel through which the evasion occurs is the overclaim of refunds, which constitute 11–23% of the potential revenue. Roughly two-fifths of the overclaimed refund is based on spurious invoices issued by invoice mills. Qualitatively, noncompliance is stronger in the latter stages of the supply chain, but it runs deep inside the chain, suggesting that on their own the self-enforcement mechanisms built into a VAT do not deter tax evasion fully.
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GEOZS, IJS, IMTLJ, KILJ, KISLJ, NLZOH, NUK, OILJ, PNG, SAZU, SBCE, SBJE, UILJ, UL, UM, UPCLJ, UPUK, ZAGLJ, ZRSKP
Using a series of Pakistani tax reforms and administrative records, I document that taxable income responses induced by to-zero tax cuts are orders of magnitude larger than ones induced by ...similar-sized other cuts. This finding is remarkably robust to alternative specifications and holds for both the self-employed and wage earners. I explore salience, selective enforcement, and discontinuous evasion costs as explanations of the observed behavior. I find that the data favor the last explanation. The difference between the two sets of responses is primarily driven by a large, discrete tax evasion response, which is included in the former but not in the latter behavior. I estimate the difference as a lower bound on tax evasion, showing that at least 70% of the income of low- and middle-income self-employed and 1% of low-income wage earners goes unreported.
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CEKLJ, IZUM, KILJ, NUK, PILJ, SAZU, UL, UM, UPUK
The value-added tax (VAT) is a cornerstone of the modern tax system. It has many desirable properties in theory: it does not distort firms' production decisions, it is difficult to evade, and it ...generates a substantial amount of revenue. Yet, in many countries there are discrepancies between the textbook model of the VAT and its practical implementation. Where the VAT implementation diverges from its textbook model, the tax may lose its desirable properties. We draw on firm-level administrative VAT records from 11 countries at different income levels to examine the functioning of real-world VAT systems. We document four stylized facts that capture departures from the textbook VAT model which are particularly pronounced in lower-income countries. We discuss the effects on VAT performance and simulate a counterfactual retail sales tax and a turnover tax. Despite its shortcomings, we conclude that the real-world VAT is superior to the alternatives.
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CEKLJ, IZUM, KILJ, NUK, PILJ, SAZU, UL, UM, UPUK
To fight evasion, many developing countries use production-inefficient tax policies. This includes minimum tax schemes whereby firms are taxed on either profits or turnover, depending on which tax ...liability is larger. Such schemes create nonstandard kink points, which allow for eliciting evasion responses to switches between profit and turnover taxes using a bunching approach. Using administrative data on corporations in Pakistan, we estimate that turnover taxes reduce evasion by up to 60–70 percent of corporate income. Incorporating this in a calibrated optimal tax model, we find that switching from profit to turnover taxation increases revenue by 74 percent without reducing aggregate profits.
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BFBNIB, CEKLJ, INZLJ, IZUM, KILJ, NMLJ, NUK, PILJ, PNG, SAZU, UL, UM, UPUK, ZRSKP
We examine two Pakistani programs to see if the public disclosure of tax information and social recognition of top taxpayers promotes tax compliance. Pakistan began revealing income tax paid by all ...taxpayers in 2012. Simultaneously, another program began recognizing and rewarding the top 100 tax- paying corporations, partnerships, self-employed individuals, and wage earners. We find that the public disclosure caused an increase of 9 log points and the social recognition program 17 log points in the tax payments of agents exposed to the program. Our results suggest that such programs can be important policy levers to mobilize additional resources.
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CEKLJ, IZUM, KILJ, NUK, PILJ, SAZU, UL, UM, UPUK
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