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VAT, tariffs, and withholding: Border taxes and informality in developing countries

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  • Keen, Michael

Abstract

This paper explores the implications of a distinctive feature of the value added tax (VAT) that is stressed by practitioners but has been largely overlooked by theorists: that it functions, in part, as a tax on the purchases of informal operators from formal sector businesses and, not least, on their imports. It also stresses the potential importance of the withholding taxes that are levied by many developing countries -- which have also been ignored. It is shown, in a simple model of informality, that if both of these instruments are optimally deployed then the usual prescription that a small economy should not deploy tariffs remains valid even in the presence of an informal sector; and a simple strategy is established -- generalizing the standard prescription developed in models without informality -- for deploying these instruments so as to preserve government revenue and increase welfare in the face of efficiency-improving tariff cuts. Conditions are established under which a VAT alone is fully optimal, precisely because it is in part a tax on informal sector production. But they are restrictive: in general, an efficient tax structure requires deploying both a VAT and withholding taxes.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 92 (2008)
Issue (Month): 10-11 (October)
Pages: 1892-1906

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Handle: RePEc:eee:pubeco:v:92:y:2008:i:10-11:p:1892-1906

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Web page: http://www.elsevier.com/locate/inca/505578

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Keywords: Value added tax Tariffs Withholding taxes Trade liberalization;

References

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  1. John Piggott & John Whalley, 2001. "VAT Base Broadening, Self Supply, and the Informal Sector," American Economic Review, American Economic Association, vol. 91(4), pages 1084-1094, September.
  2. Michael Keen & Johanna Elisabeth Ligthart, 1999. "Coordinating Tariff Reduction and Domestic Tax Reform," IMF Working Papers 99/93, International Monetary Fund.
  3. Jose Scheinkman & Aureo de Paula, 2007. "The Informal Sector," 2007 Meeting Papers 117, Society for Economic Dynamics.
  4. Baunsgaard, Thomas & Keen, Michael, 2010. "Tax revenue and (or?) trade liberalization," Journal of Public Economics, Elsevier, vol. 94(9-10), pages 563-577, October.
  5. Keen, Michael & Mintz, Jack, 2004. "The optimal threshold for a value-added tax," Journal of Public Economics, Elsevier, vol. 88(3-4), pages 559-576, March.
  6. Michael Keen & Jenny E. Ligthart, 2005. "Coordinating Tariff Reduction and Domestic Tax Reform under Imperfect Competition," Review of International Economics, Wiley Blackwell, vol. 13(2), pages 385-390, 05.
  7. Aureo de Paula & Jose A. Scheinkman, 2007. "The Informal Sector, Second Version," PIER Working Paper Archive 07-035, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 17 Oct 2007.
  8. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production: I--Production Efficiency," American Economic Review, American Economic Association, vol. 61(1), pages 8-27, March.
  9. Roger Gordon & Wei Li, 2005. "Tax Structure in Developing Countries: Many Puzzles and a Possible Explanation," NBER Working Papers 11267, National Bureau of Economic Research, Inc.
  10. M. Shahe Emran & Joseph E. Stiglitz, 2002. "On Selective Indirect Tax Reform in Developing Countries," International Trade 0210003, EconWPA.
  11. Hatzipanayotou, Panos & Michael, Michael S. & Miller, Stephen M., 1994. "Win-win indirect tax reform : A modest proposal," Economics Letters, Elsevier, vol. 44(1-2), pages 147-151.
  12. Newbery, David M., 1986. "On the desirability of input taxes," Economics Letters, Elsevier, vol. 20(3), pages 267-270.
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Citations

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Cited by:
  1. Panos Hatzipanayotou & Sajal Lahiri & Michael Michael, 2011. "Trade and domestic tax reforms in the presence of a public good and different neutrality conditions," International Tax and Public Finance, Springer, vol. 18(3), pages 273-290, June.
  2. Ronald B. Davies & Lourenço S. Paz, 2010. "Tariffs Versus VAT in the Presence of Heterogeneous Firms and an Informal Sector," Working Papers 1006, Oxford University Centre for Business Taxation.
  3. Auriol, Emmanuelle & Warlters, Michael, 2012. "The marginal cost of public funds and tax reform in Africa," Journal of Development Economics, Elsevier, vol. 97(1), pages 58-72.
  4. Robin Boadway & Motohiro Sato, 2009. "Optimal Tax Design and Enforcement with an Informal Sector," American Economic Journal: Economic Policy, American Economic Association, vol. 1(1), pages 1-27, February.
  5. Mario Mansour & Michael Keen, 2009. "Revenue Mobilization in Sub-Saharan Africa," IMF Working Papers 09/157, International Monetary Fund.
  6. Eduardo Lora & Johanna Fajardo, 2012. "Employment and Taxes in Latin America: An Empirical Study of the Effects of Payroll, Corporate Income and Value-Added Taxes on Labor Outcomes," IDB Publications 76958, Inter-American Development Bank.
  7. Michael Keen & Thomas Baunsgaard, 2005. "Tax Revenue and (or?) Trade Liberalization," IMF Working Papers 05/112, International Monetary Fund.
  8. Jenny Ligthart & Gerard C. van der Meijden, 2010. "Coordinated Tax-Tari Reforms, Informality, and Welfare Distribution," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper1029, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
  9. Keen, Michael & Lockwood, Ben, 2010. "The value added tax: Its causes and consequences," Journal of Development Economics, Elsevier, vol. 92(2), pages 138-151, July.
  10. Michael Keen, 2009. "What Do (and Don't) We Know about the Value Added Tax? A Review of Richard M. Bird and Pierre-Pascal Gendron's The VAT in Developing and Transitional Countries," Journal of Economic Literature, American Economic Association, vol. 47(1), pages 159-70, March.
  11. Niehaus, Paul & Sukhtankar, Sandip, 2013. "The marginal rate of corruption in public programs: Evidence from India," Journal of Public Economics, Elsevier, vol. 104(C), pages 52-64.
  12. Michael Keen, 2012. "Taxation and Development: Again," IMF Working Papers 12/220, International Monetary Fund.
  13. Paz, Lourenço S., 2014. "The impacts of trade liberalization on informal labor markets: A theoretical and empirical evaluation of the Brazilian case," Journal of International Economics, Elsevier, vol. 92(2), pages 330-348.
  14. Richard M. Bird & Michael Smart, 2012. "Financing Social Expenditures in Developing Countries: Payroll or Value Added Taxes?," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper1206, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.

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