Production versus Revenue Efficiency with Limited Tax Capacity: Theory and Evidence from Pakistan

Abstract

To fight evasion, many developing countries resort to 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 non-standard kink points, which allow for eliciting evasion responses to switches between profit and turnover taxes using a bunching approach. Using administrative tax records on corporations in Pakistan, we estimate that turnover taxes reduce evasion by up to 60-70% of corporate income. Incorporating this in a calibrated optimal tax model, we find that switching from profit to turnover taxation increases revenue by 74% without reducing aggregate profits, despite the production inefficiency that it introduces.

The Effects of Size-Based Regulation on Small Firms: Evidence from Vat Threshold

“…Our results add to the scarce empirical literature examining the effects of different size-based rules and regulations on firm behavior. Best et al (2015) observe that firms bunch sharply at the kink point that separates the turnover and profit tax regimes in Pakistan. They utilize variation in incentives over time and across firms to show that, unlike our results, the observed behavior is mainly driven by tax evasion.…”

“…Most previous public finance studies focus on analyzing the tax rate elasticity, that is, how much a relative change in the tax rate affects the outcome variable of interest (see e.g. Best et al (2015) and Devereux et al (2014)), ignoring the potential effects of compliance costs. Our results highlight that interpreting the behavioral response as being caused solely by the VAT rate would largely overestimate the significance of tax incentives.…”

Under the Radar: The Effects of Monitoring Firms on Tax Compliance

“…In their setting, kinks are set in terms of taxable profits, whereas in the Spanish case the tax incentive depends on operating revenue, which is considered less easily manipulable (Best et al, 2014;Carrillo, Pomeranz, and Singhal, 2014). This makes the strong bunching in reported revenue that we observe at the LTU threshold even more remarkable.…”

How Do Small Firms Respond to Tax Schedule Discontinuities? Evidence from South African Tax Registers

“…Saez, Slemrod, and Giertz (2012) and Kleven (2015). However, the literature providing similar microdata-based evidence with credible identication using data from developing countries is extremely scarce, with two studies on Pakistan being the prime exceptions (see Kleven and Waseem (2013) and Best, Brockmeyer, Kleven, Spinnewijn, and Waseem (2015)). …”

“…3 In addition to the studies on Pakistan, Kleven and Waseem (2013) and Best, Brockmeyer, Kleven, Spinnewijn, and Waseem (2015), a number of other paper on taxes in developing countries also utilize taxpayer register data. These include Carrillo, Pomeranz, and Singhal (2014) and Pomeranz (2015) who use taxpayer register data from Ecuador and Chile and combine these data with a eld or natural experiment to examine how evasion can be combated.…”