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.
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Notes
Given the available data, that is, the structure of the input–output matrix, we are required to treat imports as an aggregate commodity, rather than having disaggregated imports that compete with domestic production sectors. It is possible that this simplification might have an effect on poverty levels of certain consumer groups, although it would seem unlikely to have significant impacts on aggregate levels of poverty.
We do not explicitly model risk of apprehension, as in, for example, Allingham and Sandmo (1972). Such risk could be incorporated in our model to further enhance the modeling of tax compliance and enforcement spending.
Note that we are excluding excise taxes for technical reasons. Namely, that they violate homogeneity of prices.
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Feltenstein, A., Martinez-Vazquez, J., Datta, B. et al. A general equilibrium model of Value Added Tax evasion: an application to Pakistan. Int Econ Econ Policy 19, 537–556 (2022). https://doi.org/10.1007/s10368-022-00530-z
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DOI: https://doi.org/10.1007/s10368-022-00530-z