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“Value Added Taxes, Chain Effects and Informality”, Second Version

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Author Info
Aureo de Paula () (Department of Economics, University of Pennsylvania)
Jose A. Scheinkman () (Department of Economics, Princeton University)

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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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Publisher Info
Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 09-041.

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Length: 42 pages
Date of creation: 10 Aug 2009
Date of revision: 09 Nov 2009
Handle: RePEc:pen:papers:09-041

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Related research
Keywords: Informal Sector; VAT; Tax Avoidance;

Other versions of this item:

Find related papers by JEL classification:
H2 - Public Economics - - Taxation, Subsidies, and Revenue
H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
K4 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior

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  1. Straub, Stéphane, 2005. "Informal sector: The credit market channel," Journal of Development Economics, Elsevier, vol. 78(2), pages 299-321, December. [Downloadable!] (restricted)
    Other versions:
  2. Fortin, Bernard & Marceau, Nicolas & Savard, Luc, 1997. "Taxation, wage controls and the informal sector," Journal of Public Economics, Elsevier, vol. 66(2), pages 293-312, November. [Downloadable!] (restricted)
  3. Emran, M. Shahe & Stiglitz, Joseph E., 2005. "On selective indirect tax reform in developing countries," Journal of Public Economics, Elsevier, vol. 89(4), pages 599-623, April. [Downloadable!] (restricted)
    Other versions:
  4. Simon Johnson & Daniel Kaufman & Andrei Shleifer, 1997. "The Unofficial Economy in Transition," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(1997-2), pages 159-240. [Downloadable!]
  5. Rita Almeida & Pedro Carneiro, 2005. "Enforcement of Regulation, Informal Labor and Firm Performance," IZA Discussion Papers 1759, Institute for the Study of Labor (IZA). [Downloadable!]
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  6. Friedrich Schneider & Dominik H. Enste, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March. [Downloadable!] (restricted)
  7. Almeida, Rita & Carneiro, Pedro, 2005. "Enforcement of labor regulation, informal labor, and firm performance," Policy Research Working Paper Series 3756, The World Bank. [Downloadable!]
  8. Friedman, Eric & Johnson, Simon & Kaufmann, Daniel & Zoido-Lobaton, Pablo, 2000. "Dodging the grabbing hand: the determinants of unofficial activity in 69 countries," Journal of Public Economics, Elsevier, vol. 76(3), pages 459-493, June. [Downloadable!] (restricted)
  9. William Maloney & Jairo Mendez, 2004. "Measuring the Impact of Minimum Wages. Evidence from Latin America," NBER Chapters, in: Law and Employment: Lessons from Latin American and the Caribbean, pages 109-130 National Bureau of Economic Research, Inc. [Downloadable!]
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  10. Loayza, Norman V., 1996. "The economics of the informal sector: a simple model and some empirical evidence from Latin America," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 45(1), pages 129-162, December. [Downloadable!] (restricted)
  11. Heckman, James J, 1978. "Dummy Endogenous Variables in a Simultaneous Equation System," Econometrica, Econometric Society, vol. 46(4), pages 931-59, July. [Downloadable!] (restricted)
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  12. Dabla-Norris, Era & Gradstein, Mark & Inchauste, Gabriela, 2008. "What causes firms to hide output? The determinants of informality," Journal of Development Economics, Elsevier, vol. 85(1-2), pages 1-27, February. [Downloadable!] (restricted)
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  13. DiPasquale, Denise & Glaeser, Edward L., 1999. "Incentives and Social Capital: Are Homeowners Better Citizens?," Journal of Urban Economics, Elsevier, vol. 45(2), pages 354-384, March. [Downloadable!] (restricted)
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  14. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn. [Downloadable!] (restricted)
  15. Rivers, Douglas & Vuong, Quang H., 1988. "Limited information estimators and exogeneity tests for simultaneous probit models," Journal of Econometrics, Elsevier, vol. 39(3), pages 347-366, November. [Downloadable!] (restricted)
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