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Value Added Taxes, Chain Effects and Informality

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  • Aureo de Paula

    ()
    (Department of Economics, University of Pennsylvania)

  • Jose A. Scheinkman

    ()
    (Department of Economics, University of Pennsylvania)

Abstract

This paper investigates determinants of informal economic activity. We present an equilibrium model of informality and test its implications using a survey of 48,000+ small firms in Brazil. We define informality as tax avoidance; firms in the informal sector avoid tax payments but suffer other limitations. A novel theoretical contribution in this model is the role of value added taxes in transmitting informality. It predicts that the informality of a firm is correlated to the informality of firms from which it buys or sells. The model also implies that higher tolerance for informal firms in one production stage increases tax avoidance in downstream and upstream stages. Empirical analysis shows that, in fact, various measures of formality of suppliers and purchasers (and its enforcement) are correlated with the formality of a firm. Even more interestingly, when we look at sectors where Brazilian firms are not subject to the credit system of value added tax, but instead the value added tax is applied at some stage of production at a rate that is estimated by the tax authorities, this chain effect vanishes.

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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 09-030.

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Length: 52 pages
Date of creation: 01 Aug 2009
Date of revision:
Handle: RePEc:pen:papers:09-030

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Keywords: Informal Sector; VAT; Tax Avoidance;

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  1. James J. Heckman, 1977. "Dummy Endogenous Variables in a Simultaneous Equation System," NBER Working Papers 0177, National Bureau of Economic Research, Inc.
  2. William F. Maloney & Jairo Nunez Mendez, 2003. "Measuring the Impact of Minimum Wages: Evidence from Latin America," NBER Working Papers 9800, National Bureau of Economic Research, Inc.
  3. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 38(1), pages 77-114, March.
  4. Aureo de Paula & Jose A. Scheinkman, 2007. "The Informal Sector," PIER Working Paper Archive, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 07-033, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  5. Fajnzylber, Pablo & Maloney, William F. & Montes-Rojas, Gabriel V., 2009. "Does Formality Improve Micro-Firm Performance? Quasi-Experimental Evidence from the Brazilian SIMPLES Program," IZA Discussion Papers 4531, Institute for the Study of Labor (IZA).
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  11. Fortin, Bernard & Marceau, Nicolas & Savard, Luc, 1997. "Taxation, wage controls and the informal sector," Journal of Public Economics, Elsevier, Elsevier, vol. 66(2), pages 293-312, November.
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  14. ten Raa,Thijs, 2006. "The Economics of Input-Output Analysis," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521841795.
  15. Rita Almeida & Pedro Carneiro, 2006. "Enforcement of regulation, informal labor and firm performance," CeMMAP working papers, Centre for Microdata Methods and Practice, Institute for Fiscal Studies CWP02/06, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
  16. Stephane Straub, 2004. "Informal Sector: The Credit Market Channel," ESE Discussion Papers, Edinburgh School of Economics, University of Edinburgh 101, Edinburgh School of Economics, University of Edinburgh.
  17. M. Shahe Emran & Joseph E. Stiglitz, 2002. "On Selective Indirect Tax Reform in Developing Countries," International Trade, EconWPA 0210003, EconWPA.
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  19. Almeida, Rita & Carneiro, Pedro, 2005. "Enforcement of labor regulation, informal labor, and firm performance," Policy Research Working Paper Series, The World Bank 3756, The World Bank.
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