Taxation and Development

Paper Session

Saturday, Jan. 7, 2017 8:00 AM – 10:00 AM

Hyatt Regency Chicago, Michigan 1A & 1B
Hosted By: American Economic Association
  • Chair: Nada Eissa, Georgetown University

Not(ch) Your Average Tax System: Corporate Taxation Under Weak Enforcement

Pierre Bachas
,
University of California-Berkeley
Mauricio de Soto
,
Central Bank of Costa Rica

Abstract

The corporate income tax typically allows for all production costs to be deducted; thus in a context with evasion opportunities, firms facing higher tax rates could reduce their tax base by both deflating revenue and inflating costs. Therefore, while the elasticity of profits is a sufficient statistic for the range of optimal tax rates given a tax base, separating the profit response into a revenue and a cost elasticity is needed to determine the optimal tax base. We take advantage of Costa Rica's corporate tax design, where firms with marginally higher revenue face discontinuously higher average tax rates. We apply a novel method, which combines bunching and a discontinuity design, to estimate the profit elasticity and, for the first time, separate it into a revenue and a cost elasticity. We find that firms facing a higher tax rate slightly decrease revenue, but considerably increase costs, generating a large profit elasticity. Using additional data, we show that firms' behavioral responses appear to occur through tax evasion with no evidence of production responses. Taken together, this implies that Costa Rican firms evade taxes on 70% of their profits when faced with a 30% tax rate. In this context, we estimate the revenue maximizing rate to be below 25%. In addition, alternative tax bases, which limit cost deductibility, are preferable since they reduce evasion opportunities on this crucial margin.

Taxation, Information and Withholding: Evidence From Costa Rica

Anne Brockmeyer
,
World Bank
Marco Hernandez
,
World Bank

Abstract

This paper studies the compliance effect of tax withholding on firms, which is commonly used in developing countries. While a growing literature argues that third-party reporting of tax liabilities is a key mechanism for ensuring tax compliance, and a reason why tax capacity grows along the development path, the literature has ignored the fact that third-party reporting is often associated with tax withholding. Withholding is irrelevant if the tax withheld is fully credited against a taxpayer’s liability, but can increase compliance in the presence of costly reclaim, low salience of enforcement or extensive margin compliance gaps. To demonstrate this empirically, we exploit a ten-year panel of income and sales tax records for 400,000 firms and over 20 million third-party information and withholding reports from Costa Rica. We first document the anatomy of compliance, finding that firms are relatively compliant with third-party reports on the extensive, intensive and payment margin. When subject to third-party reporting for the first time, firms' reported taxable income increases by up to 50%. We then isolate the effect of withholding by exploiting a withholding rate increase that left reporting requirements unchanged. A doubling of the withholding rate lead to a 33% increase in sales tax payment among treated firms and an 8% increase in aggregate sales tax revenue. The mechanisms are a default payment effect and reduced misreporting. The large compliance impact of withholding rationalizes its widespread use in developing countries.

Using Technology to Improve Governance: Evidence From the Introduction of Electronic Tax Filing in Tajikistan

Oyebola Okunogbe
,
World Bank Development Research Group
Victor Pouliquen
,
Paris School of Economics and World Bank

Abstract

We study the impact of technology on governance outcomes, in particular, service delivery, corruption and tax payments, by examining the adoption and subsequent impact of electronic tax filing (e-filing) in Tajikistan. E-filing allows taxpayers to file their taxes online; in its absence, taxpayers submit their monthly tax declarations in-person to tax officials, resulting in high compliance costs and opportunities for rent-seeking behavior. Using a randomized experiment, we find that training firms to e-file and helping them register for e-filing is highly successful at promoting e-filing adoption, as 93 percent of treated firms start to e-file. In contrast, e-filing training alone does not result in any significant difference in adoption compared to a control group with a 59 percent adoption rate. Further, we find evidence of important selection mechanisms: firms reporting extortion from tax officials are more likely to e-file while firms with a higher likelihood of evading taxes (who may benefit from colluding with tax officials) are less likely to e-file. Once firms start to e-file, they spend almost five fewer hours each month complying with tax obligations and are less likely to have tax officials coerce their tax declarations. We find no average significant effects of e-filing on tax payments, but observe significant heterogeneity across firms: among firms with a higher likelihood of evasion (as measured by a risk index developed by the tax authority), firms that e-file pay about $3,600 USD more taxes on average over one year. In all, the results suggest that e-filing helps to close the revenue gap between firms that were likely evading taxes and those that were not.

Employment Structure and the Rise of the Modern Tax System

Anders Jensen
,
London School of Economics and Political Science

Abstract

This paper studies how the transition from self-employment to employee-jobs over the long run of development can explain growth in income tax capacity. I construct a new database which covers 90 household surveys across countries at different income levels and 140 years of historical data within the US (1870-2010). Using these data, I first establish three new stylized facts: 1) within country, the share of employees increases over the income distribution, and increases at all levels of income as a country develops; 2) the income tax exemption threshold moves down the income distribution as a country develops tracking employee growth; 3) the employee share above the income tax threshold remains high and constant at 80-85 percent. These findings are consistent with a model where a high employee share is a necessary condition for taxation and where the rise in income covered by information trails through increases in employee shares drives expansion of the income tax base. To provide a causal estimate of the impact of employee share on the exemption threshold, I study a state-led US development program implemented in the 1950s-60s which shifted up the level of employee share. The identification strategy exploits within-state changes in court-litigation status which generates quasi-experimental variation in the effective implementation date of the program. I find that the exogenous increase in employee share is associated with an expansion of the state income tax base and an increase in state income tax revenue.
Discussant(s)
Nada Eissa
,
Georgetown University
Youssef Benzarti
,
University of California-Los Angeles
Lorenzo Casaburi
,
University of Zurich
Andrew Zeitlin
,
Georgetown University
JEL Classifications
  • H2 - Taxation, Subsidies, and Revenue
  • O1 - Economic Development