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Tariffs versus VAT in the presence of heterogeneous firms and an informal sector

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  • Ronald Davies

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  • Lourenço Paz

Abstract

The debate over the use of tariffs or value added taxes in developing countries has focused on the difficulty of collecting VAT from the informal sector of the economy. This paper contributes by considering this issue with heterogeneous firms and endogenous entry. This yields two new results. First, a cut in the tariff in and of itself can reduce the size of the informal sector. Second, the imposition of a VAT need not increase the number of informal firms. In fact, for many parameterizations of the model, higher VAT reduces informality. Despite this, whether a revenue neutral shift from tariffs to VAT increases or decreases welfare depends on the parametrization. Therefore while this move may be welfare improving in some cases, it is not a one-size fits all policy.

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

Article provided by Springer in its journal International Tax and Public Finance.

Volume (Year): 18 (2011)
Issue (Month): 5 (October)
Pages: 533-554

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Handle: RePEc:kap:itaxpf:v:18:y:2011:i:5:p:533-554

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Web page: http://www.springerlink.com/link.asp?id=102915

Related research

Keywords: Value added tax; Tariffs; Informal markets; Firm heterogeneity; H2; H8; F1;

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References

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  1. Gatti, Roberta & Honorati, Maddalena, 2007. "Informality among Formal Firms: Firm-level, Cross-country Evidence on Tax Compliance and Access to Credit," CEPR Discussion Papers 6597, C.E.P.R. Discussion Papers.
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  14. Matthew T. Cole (University College Dublin) Ronald B. Davies (University College Dublin), 2009. "Optimal Tariffs, Tariff Jumping, and Heterogeneous Firms," The Institute for International Integration Studies Discussion Paper Series iiisdp302, IIIS.
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Citations

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Cited by:
  1. Bauer, Christian & Davies, Ronald B. & Haufler, Andreas, 2011. "Economic integration and the optimal corporate tax structure with heterogeneous firms," Discussion Papers in Economics 12310, University of Munich, Department of Economics.
  2. Michael S. Michael & Panos Hatzipanayotou, 2012. "Pollution and Reforms of Domestic and Trade Taxes towards Uniformity," University of Cyprus Working Papers in Economics 11-2012, University of Cyprus Department of Economics.
  3. Paz, Lourenco, 2012. "The effect of trade liberalization on payroll tax evasion and labor informality," MPRA Paper 39545, University Library of Munich, Germany.
  4. 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.
  5. 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.

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