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Tariffs Versus VAT in the presence of heterogeneous firms and an informal sector

Listed author(s):
  • Ronald B. Davies
  • Lourenço Paz

The debate over the use of tariffs or value added taxes in developing countries has focused on the difficulty of collecting VAT from the informal sector of the economy. This paper contributes by considering this issue with heterogeneous firms and endogenous entry. This yields two new results. First, a cut in the tariff in and of itself can reduce the size of the informal sector. Second, the imposition of a VAT need not increase the number of informal firms. In fact, for many parameterizations of the model, higher VAT reduces informality. Despite this, whether a revenue neutral shift from tariffs to VAT increases or decreases welfare depends on the parametrization. Therefore while this move may be welfare improving in some cases, it is not a one-size fits all policy.

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File URL: http://hdl.handle.net/10197/2641
File Function: First version, 2010
Download Restriction: no

Paper provided by School of Economics, University College Dublin in its series Working Papers with number 201008.

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Date of creation: Apr 2010
Handle: RePEc:ucn:wpaper:201008
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  4. Ronald B. Davies & Carsten Eckel, 2010. "Tax Competition for Heterogeneous Firms with Endogenous Entry," American Economic Journal: Economic Policy, American Economic Association, vol. 2(1), pages 77-102, February.
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  8. Gatti, Roberta & Honorati, Maddalena, 2007. "Informality among Formal Firms: Firm-level, Cross-country Evidence on Tax Compliance and Access to Credit," CEPR Discussion Papers 6597, C.E.P.R. Discussion Papers.
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  15. Matthew T. Cole & Ronald B. Davies, 2009. "Optimal tariffs, tariff jumping, and heterogeneous firms," Working Papers 200919, School of Economics, University College Dublin.
  16. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March.
  17. Keen, Michael & Ligthart, Jenny E., 2002. "Coordinating tariff reduction and domestic tax reform," Journal of International Economics, Elsevier, vol. 56(2), pages 489-507, March.
  18. Matthew T. Cole, 2009. "The choice of modeling firm heterogeneity and trade restrictions," Working Papers 200920, School of Economics, University College Dublin.
  19. Piermartini, Roberta, 2004. "The role of export taxes in the field of primary commodities," WTO Discussion Papers 4, World Trade Organization (WTO), Economic Research and Statistics Division.
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