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A general equilibrium model of Value Added Tax evasion: an application to Pakistan

Author

Listed:
  • Andrew Feltenstein

    (Georgia State University)

  • Jorge Martinez-Vazquez

    (Georgia State University)

  • Biplab Datta

    (Augusta University)

  • Sohani Fatehin

    (Dickinson College
    Johns Hopkins University)

Abstract

Value Added Taxes (VAT) constitute a major share of tax revenues in developing countries in which tax evasion is widespread. The literature on VAT evasion, however, is relatively scant. This paper develops a computable general equilibrium framework for analyzing endogenous VAT tax evasion. The analytical framework entails increasing enforcement through greater spending on the enforcement of tax revenue collection. We assume that there is an elasticity that connects the changes in enforcement to actual increases in VAT collection. We apply the model to Pakistan data and show the level of enforcement spending required to achieve certain VAT collection targets. We also examine the short-, medium-, and long-term macroeconomic outlooks, and real consumption distribution across household economic groups associated with higher enforcement spending. We calibrate the model using 2016 as the base year and then run the dynamic model forward for 20 years. We define the implicit VAT rate as that hypothetical statutory rate that, in the absence of evasion, would approximately generate the observed VAT collection. We assume zero additional spending on enforcement in the baseline and estimate two alternative scenarios of VAT revenue target of 8% and 15% of the GDP. The alternative scenarios require increase in enforcement spending by a compounded 46.4% and 322.4%, respectively. We find that the increased enforcement spending enhances the sustainability of the government’s budget deficit without causing a decline in real GDP over the long-term. The interest and inflation rates are also lowered. However, there is a small regressive impact on households’ real consumption.

Suggested Citation

  • Andrew Feltenstein & Jorge Martinez-Vazquez & Biplab Datta & Sohani Fatehin, 2022. "A general equilibrium model of Value Added Tax evasion: an application to Pakistan," International Economics and Economic Policy, Springer, vol. 19(3), pages 537-556, July.
  • Handle: RePEc:kap:iecepo:v:19:y:2022:i:3:d:10.1007_s10368-022-00530-z
    DOI: 10.1007/s10368-022-00530-z
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    More about this item

    Keywords

    Value Added Tax; Tax evasion; Tax enforcement; Computable general equilibrium; Macroeconomic outlook;
    All these keywords.

    JEL classification:

    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models

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