Abstract
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. This paper contributes by considering this issue with heterogeneous firms and endogenous entry. This yields two results. First, a cut in the tariff reduces the size of the informal sector. Second, the imposition of VAT need not increase the size of the informal sector. Turning to simulation results, we find that switching from a tariff to a revenue-neutral VAT increases welfare, in part because of the selection effect generated by heterogeneous firms.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
References
Baunsgaard, T., & Keen, M. (2005). Tax revenue and (or?) trade liberalization. IMF Working Paper WP/05/112.
Bird, R. M., & Gendron, P. (2007). The VAT in developing and transitional countries. New York: Cambridge University Press.
Boadway, R., & Sato, M. (2009). Optimal tax design and enforcement with an informal sector. American Economic Journal: Economic Policy, 1, 1–27.
Boccanfuso, D., de Quatrebarbes, C., & Savard, L. (2011). Can the removal of VAT exemptions support the poor? The case of Niger. CERDI, Etudes et Documents, E 2011.06.
Cole, M. (forthcoming). The choice of modeling firm heterogeneity and trade restrictions. Review of World Economics.
Cole, M., & Davies, R. (2011). Optimal tariffs, tariff jumping, and heterogeneous firms. European Economic Review, 55, 480–496.
Chor, D. (2009). Subsidies for FDI: implications from a model with heterogeneous firms. Journal of International Economics, 78, 113–125.
Davies, R. B., & Eckel, C. (2010). Tax competition for heterogeneous firms with endogenous entry. American Economic Journal: Economic Policy, 2, 77–102.
Devarajan, S., Delfin, S., & Li, H. (1999). Quantifying the fiscal effects of trade reform: a general equilibrium model estimated for 60 countries. Mimeo, World Bank.
Ebrill, L., Keen, M., Bodin, J., & Summers, V. (2001). The modern VAT, Washington D.C.
Emran, M. S., & Stiglitz, J. E. (2005). On selective indirect tax reform in developing countries. Journal of Public Economics, 89, 599–623.
Flam, H., & Helpman, E. (1987). Industrial policy under monopolistic competition. Journal of International Economics, 22, 79–102.
Gatti, R., & Honorati, M. (2008). Informality among formal firms: firm-level, cross-country evidence on tax compliance and access to credit industrial policy under monopolistic competition. Policy Research Paper 4476, World Bank.
Helpman, E., Melitz, M., & Yeaple, S. (2004). Export versus FDI with heterogeneous firms. American Economic Review, 94, 300–316.
Jørgensen, J., & Schröder, P. (2008). Fixed export cost heterogeneity, trade and welfare. European Economic Review, 52, 1256–1274.
Keen, M. (2008). VAT, tariffs, and withholding: border taxes and informality in developing countries. Journal of Public Economics, 92, 1892–1906.
Keen, M., & Ligthart, J. (2002). Coordinating tariff reduction and domestic tax reform. Journal of International Economics, 56, 489–507.
Krugman, P. R. (1979). Increasing returns, monopolistic competition, and international trade. Journal of International Economics, 9, 469–479.
Melitz, M. (2003). The impact of trade on intra-industry reallocations and aggregate industry productivity. Econometrica, 71, 1695–1725.
Munk, K. J. (2008). On the rational for the use of border taxes in developing countries. Working Paper.
Paz, L. S. (2009). The impacts of trade liberalization on informal labor markets. Working Paper.
Perry, G., Maloney, W., Arias, O., Fajnzylber, P., Mason, A., & Saavedra-Chanduvi, J. (2007). Informality: Exit and exclusion. World Bank Latin American and Caribbean studies. Washington D.C.: The World Bank.
Piermartini, R. (2004). The role of export taxes in the field of primary commodities. World Trade Organization, pp. 1–24.
Piggot, J., & Whalley, J. (2001). VAT base broadening, self supply, and the informal sector. American Economic Review, 91, 1084–1094.
Organization for Economic Cooperation and Development (2003). OECD model tax convention on income and investment. Paris: OECD Committee on Fiscal Affairs.
Schneider, F., & Enste, D. (2000). Shadow economies: size, causes, and consequences. Journal of Economic Literature, 38, 77–114.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Davies, R.B., Paz, L.S. Tariffs versus VAT in the presence of heterogeneous firms and an informal sector. Int Tax Public Finance 18, 533–554 (2011). https://doi.org/10.1007/s10797-011-9186-8
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10797-011-9186-8