Self-Enforcing Tax Design and Supply Chain Formalization: Evidence from India’s GST Reform

I study India’s 2017 Goods and Services Tax (GST) to examine how self-enforcing tax design generates formalization cascades through supply chains. GST created incentives for formal procurement by allowing input tax credits only for purchases from registered suppliers. Using firm-level data on 12,024 firms, I find that firms at the mean pre-reform exposure to non-creditable taxes increased documented input purchases by 6 percent while reducing tax payments by 8 percent. Effects double over five years, consistent with formalization propagating sequentially upstream—a dynamic pattern that provides the first empirical evidence on the dynamics of VAT-driven formalization cascades. At the aggregate level, large firms’ share of national GST collections fell from 46 to 30 percent, implying smaller enterprises entering the formal tax net. The interquartile range of effective tax rates collapsed by 72 percent, reflecting the replacement of heterogeneous cascading taxes with uniform credits.