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

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  • Aureo de Paula

    ()
    (Department of Economics, University of Pennsylvania)

  • Jose A. Scheinkman

    ()
    (Department of Economics, Princeton University)

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 09-041.

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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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Keywords: Informal Sector; VAT; Tax Avoidance;

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References

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  1. M. Shahe Emran & Joseph E. Stiglitz, 2002. "On Selective Indirect Tax Reform in Developing Countries," International Trade 0210003, EconWPA.
  2. James J. Heckman & Carmen Pagés, 2004. "Law and Employment: Lessons from Latin America and the Caribbean," NBER Books, National Bureau of Economic Research, Inc, number heck04-1.
  3. Aureo de Paula & Jose A Sheinkman, 2007. "The Informal Sector," Levine's Bibliography 122247000000001663, UCLA Department of Economics.
  4. Almeida, Rita & Carneiro, Pedro, 2005. "Enforcement of labor regulation, informal labor, and firm performance," Policy Research Working Paper Series 3756, The World Bank.
  5. 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.
  6. Almeida, Rita K. & Carneiro, Pedro, 2005. "Enforcement of Regulation, Informal Labor and Firm Performance," IZA Discussion Papers 1759, Institute for the Study of Labor (IZA).
  7. James J. Heckman, 1977. "Dummy Endogenous Variables in a Simultaneous Equation System," NBER Working Papers 0177, National Bureau of Economic Research, Inc.
  8. 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.
  9. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March.
  10. 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).
  11. Loayza, Norman A., 1997. "The economics of the informal sector : a simple model and some empirical evidence from Latin America," Policy Research Working Paper Series 1727, The World Bank.
  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.
  13. 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.
  14. Straub, Stéphane, 2005. "Informal sector: The credit market channel," Journal of Development Economics, Elsevier, vol. 78(2), pages 299-321, December.
  15. 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.
  16. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
  17. 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(2), pages 159-240.
  18. 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.
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Cited by:
  1. 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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