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Increasing the substitution elasticity can improve VAT compliance and social welfare

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  • Bognetti, Giuseppe
  • Santoni, Michele

Abstract

This paper presents a model of Value Added Tax (VAT) evasion in a monopolistically competitive closed economy. The paper shows that an increase in the intra-brand elasticity of substitution can lower output VAT evasion when under-reporting of final sales and input VAT credits occur jointly. Because of the improvement in VAT compliance, equilibrium prices will fall and VAT revenues will rise both in the short and in the long run. Disentangling the love of variety and the elasticity of substitution utility parameters, it turns out that, in a symmetric general equilibrium solution with free entry and exit of firms, an increase in the substitution elasticity is welfare improving when love of variety is not too strong.

Suggested Citation

  • 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.
  • Handle: RePEc:eee:ecmode:v:58:y:2016:i:c:p:293-307
    DOI: 10.1016/j.econmod.2016.06.005
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    References listed on IDEAS

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    More about this item

    Keywords

    Monopolistic competition; VAT evasion;

    JEL classification:

    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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