“Value Added Taxes, Chain Effects and Informalityâ€, Second Version

Aureo de Paula and Jose Scheinkman

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: This paper investigates determinants of informal economic activity. We present an equilibrium model of informality and test its implications using a survey of 48,000+ small firms in Brazil. We define informality as tax avoidance; firms in the informal sector avoid tax payments but suffer other limitations. A novel theoretical contribution in this model is the role of value added taxes in transmitting informality. It predicts that the informality of a firm is correlated to the informality of firms from which it buys or sells. The model also implies that higher tolerance for informal firms in one production stage increases tax avoidance in downstream and upstream stages. Empirical analysis shows that, in fact, various measures of formality of suppliers and purchasers (and its enforcement) are correlated with the formality of a firm. Even more interestingly, when we look at sectors where Brazilian firms are not subject to the credit system of value added tax, but instead the value added tax is applied at some stage of production at a rate that is estimated by the tax authorities, this chain effect vanishes.

Keywords: Informal Sector; VAT; Tax Avoidance (search for similar items in EconPapers)
JEL-codes: H2 H3 K4 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2009-08-10, Revised 2009-11-09
New Economics Papers: this item is included in nep-acc and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:pen:papers:09-041

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