Misreporting in the Value-Added Tax and the Optimal Enforcement

Abstract

A common fraud by registered traders in the value-added tax system is under-reporting sales and over-reporting purchases. This paper models this problem by linking the level of misreporting to the risk-aversion of taxpayers and the level of transactions with final consumers. In addition, it analyses the enforcement consequences of the new developments in information reporting and electronic invoicing, which enable the tax authority to randomly cross-check the invoices. The results highlight the importance of taxpayer's subjective beliefs in shaping audit policy of the tax authority. The optimal audit rate for risk-neutral firms is an increasing function of transaction with final consumers, but this relationship may turn to be negative for risk-averse taxpayers. Moreover, the optimal level of invoice cross-checking on transactions of each commodity is positively associated with the number of trading firms.

Identifying suspicious groups of affiliated-transaction-based tax evasion in big data

“…Thus, via traditional tax auditing methods, addressing a large volume of taxation information in an efficient and effective manner is impossible. In practice, tax authorities are only able to screen a small percentage of tax reports for further auditing because of limited staff resources [24]. Thus, countering ATTE via traditional tax auditing methods is not feasible.…”

Value‐Added Tax, Input–Output Linkages and Informality

“…Generally, this paper neglects some other VAT enforcement issues, as stressed in Keen and Smith (), like underreported sales and overreported purchases, multiple rates and misclassification of commodities, self‐consumption and carousel fraud. In an accompanying paper (Hoseini ), the misreporting in VAT is studied in detail, but international aspects of VAT fraud like missing trader (carousel) fraud need further attention from theorists. In spite of these limitations, the findings of this paper have a novel implication for VAT enforcement design, especially for countries suffering from a large shadow economy.…”

“…() find that tax evasion varies negatively with bank branch penetration and credit information sharing, and the effect is stronger in more financially‐dependent industries. As a result, a persistent productivity gap between informal and formal firms exists (La Porta and Shleifer ), and it is wider in industries that are highly dependent on external finance (Gordon and Li ; Beck and Hoseini ).…”

“…In order to use this information and make a credible threat to informal firms, the tax administration needs to spend resources on this type of enforcement. In practice, as the cost of using the third‐party reported information is far less than the revenue that it can generate, in all countries with a VAT, either the transaction records are collected electronically in an integrated system, or formal firms have to provide them in case of a random audit (Hoseini ). Therefore in all VAT systems, unilateral evasion in a trade with formal firms generates a credible threat of getting caught as an informal firm.…”

“… Although this definition ignores the possibility of misreporting in the formal sector, one can assume that each representative firm sells one part of its production in the formal market () and one part in the informal market () with no change in the results. For a more detailed analysis of misreporting in VAT, see Hoseini (). …”