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The collection efficiency of the value added tax: theory and international evidence

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  • Aizenman, Joshua
  • Jinjarak, Yothin

Abstract

This paper evaluates the political economy and structural factors explaining the collection efficiency of the Value Added Tax [VAT]. We consider the case where the collection efficiency is determined by the probability of audit and by the penalty on underpaying. Implementation lags imply that the present policy maker determines the efficiency of the tax system next period. Theory suggests that the collection efficiency is impacted by political economy considerations – greater polarization and political instability would reduce the efficiency of the tax collection. In addition, collection is impacted by structural factors affecting the ease of tax evasion, like the urbanization level, the share of agriculture, and trade openness. Defining the collection efficiency of the VAT as the ratio of the VAT revenue to aggregate consumption divided by the standard VAT rate, we evaluate the evidence on VAT collection efficiency in a panel of 44 countries over 1970-99. The results are consistent with the theory - a one standard deviation increase in durability of political regime, and in the ease and fluidity of political participation, increase the VAT collection efficiency by 3.1% and 3.6%, respectively. A one standard deviation increase in urbanization, trade openness, and the share of agriculture changes the VAT collection efficiency by 12.7%, 3.9%, and - 4.8%, respectively. In addition, a one standard deviation increase in GDP/Capita increases the tax efficiency by 8.1%. Qualitatively identical results apply for an alternative measure of VAT collection efficiency, defined by the ratio of VAT revenue to GDP divided by the standard VAT.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt42d103zh.

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Date of creation: 01 Aug 2005
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Handle: RePEc:cdl:ucscec:qt42d103zh

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Keywords: VAT; tax collection costs; trade openness; political instability; urbanization;

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  1. Baunsgaard, Thomas & Keen, Michael, 2010. "Tax revenue and (or?) trade liberalization," Journal of Public Economics, Elsevier, vol. 94(9-10), pages 563-577, October.
  2. Fisman, Raymond & Wei, Shang-Jin, 2001. "Tax Rates and Tax Evasion: Evidence from 'Missing Imports' in China," CEPR Discussion Papers 3089, C.E.P.R. Discussion Papers.
  3. Cukierman, Alex & Edwards, Sebastian & Tabellini, Guido, 1992. "Seigniorage and Political Instability," American Economic Review, American Economic Association, vol. 82(3), pages 537-55, June.
  4. M. Shahe Emran & Joseph E. Stiglitz, 2002. "On Selective Indirect Tax Reform in Developing Countries," International Trade 0210003, EconWPA.
  5. 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.
  6. Alan J. Auerbach & Roger H. Gordon, 2002. "Taxation of Financial Services under a VAT," American Economic Review, American Economic Association, vol. 92(2), pages 411-416, May.
  7. Joshua Aizenman & Ilan Noy, 2004. "Endogenous Financial and Trade Openness: Efficiency and Political Economy Considerations," Working Papers 200404, University of Hawaii at Manoa, Department of Economics.
  8. Gordon, Roger H. & Bo Nielsen, Soren, 1997. "Tax evasion in an open economy:: Value-added vs. income taxation," Journal of Public Economics, Elsevier, vol. 66(2), pages 173-197, November.
  9. M. Ayhan Kose & Kenneth Rogoff & Eswar Prasad & Shang-Jin Wei, 2003. "Effects of Financial Globalization on Developing Countries," IMF Occasional Papers 220, International Monetary Fund.
  10. Joshua Aizenman, 2004. "Financial Opening and Development: Evidence and Policy Controversies," American Economic Review, American Economic Association, vol. 94(2), pages 65-70, May.
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