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Tariffs Versus VAT in the Presence of Heterogeneous Firms and an Informal Sector

Author

Listed:
  • Ronald B Davies

    (University College Dublin)

  • Lourenço S Paz

    (Syracuse University)

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.

Suggested Citation

  • Ronald B Davies & Lourenço S Paz, 2010. "Tariffs Versus VAT in the Presence of Heterogeneous Firms and an Informal Sector," Working Papers 201008, School of Economics, University College Dublin.
    • Handle: RePEc:ucn:wpaper:201008
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    References listed on IDEAS

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    Cited by:

    1. Bauer, Christian & Davies, Ronald B. & Haufler, Andreas, 2014. "Economic integration and the optimal corporate tax structure with heterogeneous firms," Journal of Public Economics, Elsevier, vol. 110(C), pages 42-56.
    2. Creane, Anthony & Jeitschko, Thomas D., 2016. "Exporting to bypass weak institutions," European Economic Review, Elsevier, vol. 83(C), pages 185-197.
    3. Kowsar Yousefi & Mohammad Vesal, 2023. "The Double Dividend of a Joint Tariff and VAT Reform: Evidence from Iran," The World Bank Economic Review, World Bank, vol. 37(2), pages 331-349.
    4. Michael Michael & Panos Hatzipanayotou, 2013. "Pollution and reforms of domestic and trade taxes towards uniformity," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 20(5), pages 753-768, October.
    5. Paz, Lourenco, 2012. "The impacts of trade liberalization on informal labor markets: an evaluation of the Brazilian case," MPRA Paper 38858, University Library of Munich, Germany.
    6. 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.
    7. Lourenço S. Paz, 2015. "The welfare impacts of a revenue-neutral switch from tariffs to VAT with intermediate inputs and a VAT threshold," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 24(4), pages 465-498, June.
    8. Dennis Becker, 2018. "Heterogeneous firms and informality: the effects of trade liberalization on labour markets," Oxford Economic Papers, Oxford University Press, vol. 70(1), pages 47-72.
    9. Barbara Annicchiarico & Claudio Cesaroni, 2018. "Tax reforms and the underground economy: a simulation-based analysis," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 25(2), pages 458-518, April.
    10. 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;International Institute of Public Finance, vol. 18(3), pages 273-290, June.
    11. Bognetti, Giuseppe & Santoni, Michele, 2016. "Increasing the substitution elasticity can improve VAT compliance and social welfare," Economic Modelling, Elsevier, vol. 58(C), pages 293-307.
    12. Fabio Antoniou & Panos Hatzipanayotou & Michael S. Michael & Nikos Tsakiris, 2022. "Tax competition in the presence of environmental spillovers," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 29(3), pages 600-626, June.
    13. Liu, Ailan & Wang, Zhixuan & Zhu, Pengcheng, 2021. "Does informal economy undermine the effects of China’s aid on its outward foreign direct investment?," International Review of Economics & Finance, Elsevier, vol. 75(C), pages 315-329.
    14. Caro, Paolo Di & Sacchi, Agnese, 2020. "The heterogeneous effects of labor informality on VAT revenues: Evidence on a developed country," Journal of Macroeconomics, Elsevier, vol. 63(C).

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    JEL classification:

    • F1 - International Economics - - Trade
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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