Researcher: Divya Singh, PhD Student in Economics

Consumption taxes form a significant part of governments’ revenues in developing countries. In recent years, Value-added tax (VAT) has emerged as a popular tax instrument- more than a hundred countries have moved from traditional retail sales tax to a VAT system in past two decades. A major factor that lends superiority to VAT over traditional sales tax is that under a VAT, a firm can deduct tax paid on its inputs from taxes paid on the output, conditional on furnishing invoices of its purchase. This allows for cross-reporting of firm-to-firm transactions and therefore leads to self-enforcement under VAT. This implies that in settings of high evasion and low fiscal capacity, VAT is likely to be more revenue efficient.

This project plans to analyze production responses of firms to VAT, in addition to its revenue effects. In the first part of the project, the project will attempt to understand if firms vertically integrate under VAT to evade taxes. This is because compared to the last firm in the production chain who sells to the consumers directly and its sales are not subject to cross-reporting, the second last firm has a strategic disadvantage-- it sells to a firm and hence its sales are subject to cross-reporting. This creates incentives for the second last firm to integrate with the last firm to evade taxes under VAT. Secondly the research will explore the revenue consequences of the VAT reform.