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Too Low to Be True: The Use of Minimum Thresholds to Fight Tax Evasion

  • Tonin, Mirco

    ()

    (University of Southampton)

The enforcement of compliance with tax regulation is a complex task. This is particularly the case when the administrative capacity of the tax authority is low, as it often happens in developing and transition countries. This paper draws on some international experiences in fighting tax evasion to identify tools that can be used to reduce underreporting by employed labor, small and medium enterprises, self-employed, and professionals. In particular, I analyze the use of minimum thresholds, where taxpayers cannot declare an income below a certain amount or, alternatively, are subject to a higher probability of an audit if they decide to do so. First, I model the impact of minimum thresholds by explicitly taking into account low administrative capacity. The model shows that introducing a threshold creates a spike and a "missing middle" in the distribution of declared incomes and highlights under which conditions a threshold is likely to increase net revenues. I then analyze two policies used to fight underreporting: the Italian "Business Sector Analysis" and the Bulgarian "Minimum Social Insurance Thresholds". The Italian tax authority infers "normal" revenues and compensations by small and medium enterprises, self-employed, and professionals from indicators that are difficult to conceal or manipulate. In case the taxpayer decides to declare less than the "normal" level, the probability of an audit increases and the burden of proof is reversed. Bulgaria has established a system of differentiated minimum social insurance thresholds depending on sector and profession, so that social security contributions cannot be lower than the ones implied by the threshold. To conclude, I appraise the applicability of these two systems in other countries.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 5509.

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Length: 34 pages
Date of creation: Feb 2011
Date of revision:
Publication status: published in: Clemens Fuest and George R. Zodrow (eds.), Critical Issues in Taxation and Development, Cambridge (MA), MIT press, 2013
Handle: RePEc:iza:izadps:dp5509
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  1. Yitzhaki, Shlomo, 1974. "Income tax evasion: A theoretical analysis," Journal of Public Economics, Elsevier, vol. 3(2), pages 201-202, May.
  2. Roy W. Bahl & Richard M. Bird, 2008. "Tax Policy in Developing Countries: Looking Back and Forward," Working Papers Series 13, Rotman Institute for International Business, Joseph L. Rotman School of Management, University of Toronto, revised May 2008.
  3. Joel Slemrod, 2007. "Cheating Ourselves: The Economics of Tax Evasion," Journal of Economic Perspectives, American Economic Association, vol. 21(1), pages 25-48, Winter.
  4. Macho-Stadler, Ines & Perez-Castrillo, J David, 1997. "Optimal Auditing with Heterogeneous Income," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(4), pages 951-68, November.
  5. Slemrod, Joel & Yitzhaki, Shlomo, 2002. "Tax avoidance, evasion, and administration," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 22, pages 1423-1470 Elsevier.
  6. Gindling, T.H. & Terrell, Katherine, 2007. "The effects of multiple minimum wages throughout the labor market: The case of Costa Rica," Labour Economics, Elsevier, vol. 14(3), pages 485-511, June.
  7. Richard M. Bird, 2003. "Administrative Dimensions of Tax Reform," International Tax Program Papers 0302, International Tax Program, Institute for International Business, Joseph L. Rotman School of Management, University of Toronto, revised May 2003.
  8. Erard, Brian, 1997. "Self-selection with measurement errors A microeconometric analysis of the decision to seek tax assistance and its implications for tax compliance," Journal of Econometrics, Elsevier, vol. 81(2), pages 319-356, December.
  9. Konstantin Pashev, 2006. "Presumptive Taxation: Lessons from Bulgaria," Post-Communist Economies, Taylor & Francis Journals, vol. 18(4), pages 399-418.
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