Working Paper: CEPR ID: DP9717
Authors: Michael Best; Anne Brockmeyer; Henrik Kleven; Johannes Spinnewijn; Mazhar Waseem
Abstract: This paper analyzes the design of tax systems under imperfect enforcement. A common policy in developing countries is to impose minimum tax schemes whereby firms are taxed either on profits or on turnover, depending on which tax liability is larger. This production inefficient tax policy has been motivated by the idea that the broader turnover tax base is harder to evade. Minimum tax schemes give rise to a kink point in firms' choice sets as the tax rate and tax base jump discontinuously when one tax liability surpasses the other. Using administrative tax records on corporations in Pakistan, we find large bunching around the minimum tax kink. We show that the combined tax rate and tax base change at the kink provides small real incentives for bunching, making the policy ideal for eliciting evasion. We develop an empirical approach allowing us to put (tight) bounds on the evasion response to switches between profit and turnover taxation, and find that turnover taxes reduce evasion by up to 60-70% of corporate income. Our analysis sheds new light on the use of production-inefficient tax tools in countries with limited tax capacity and can easily be replicated in other contexts as the quasi-experimental variation needed is ubiquitous.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| minimum tax schemes (H26) | significant bunching of corporate profits (G35) |
| minimum tax schemes (H26) | tax evasion (H26) |
| turnover taxes (H25) | corporate tax evasion (H26) |
| profit taxes (H25) | corporate tax evasion (H26) |
| bunching (C92) | evasion responses (H26) |