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Value‐Added Tax, Input–Output Linkages and Informality

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  • Mohammad Hoseini

Abstract

This paper analyses the impact of adopting a value‐added tax (VAT) on the size of the informal sector across different activities. Under VAT, formal traders desire to purchase their inputs from formal suppliers for a deduction in their tax bill. I model this ‘self‐enforcement’ feature of VAT on an input–output economy and quantify it among different activities using a forward linkage index. The administration can reduce the size of the informal economy by reallocating the audits to activities with higher backward linkages and final consumption. Empirical evidence from the Indian services sector justifies the theoretical results and shows a significant increase in the tax compliance of forwardly linked activities following the VAT adoption in 2003.

Suggested Citation

  • Mohammad Hoseini, 2020. "Value‐Added Tax, Input–Output Linkages and Informality," Economica, London School of Economics and Political Science, vol. 87(347), pages 813-843, July.
    • Handle: RePEc:bla:econom:v:87:y:2020:i:347:p:813-843
    DOI: 10.1111/ecca.12310
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    References listed on IDEAS

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    1. Yan Zhang & Zhuoran Bai & Christopher Findlay, 2024. "Value-added tax reform and service exports: Evidence from China," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 33(4), pages 551-573, May.

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