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Myth and Reality of Flat Tax Reform: Micro Estimates of Tax Evasion Response and Welfare Effects in RussiaYuriy GorodnichenkoUniversity of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); Institute for the Study of Labor (IZA) Jorge Martinez-VazquezGeorgia State University - Andrew Young School of Policy Studies Klara Sabirianova PeterUniversity of North Carolina - Chapel Hill; Institute for the Study of Labor (IZA); Centre for Economic Policy Research (CEPR) June 2008 Andrew Young School of Policy Studies Research Paper Series No. 08-25 Abstract: Using micro-level data, we examine the effects of Russia's 2001 flat rate income tax reform on consumption, income, and tax evasion. We use the gap between household expenditures and reported earnings as a proxy for tax evasion with data from a household panel for 1998-2004. Utilizing difference-in-difference and regression-discontinuity-type approaches, we find that large and significant changes in tax evasion following the flat tax reform are associated with changes in voluntary compliance. We rule out alternative explanations based on changes in tax enforcement effort, savings behavior, expenditures on durables, and others. We also find that the productivity response of taxpayers to the flat tax reform is small relative to the tax evasion response. Finally, we develop a feasible framework to assess the deadweight loss from personal income tax in the presence of tax evasion based on the consumption response to tax changes. We show that because of the strong tax evasion response the efficiency gains from the Russian flat tax reform are at least 30% smaller than the gains implied by conventional approaches.
Number of Pages in PDF File: 64 Keywords: Tax Evasion, consumption-income gap, personal income tax, flat tax, difference-in-difference, regression discontinuity, deadweight loss, transition, Russia JEL Classification: D73, H24, H36, J3, O1, P2 working papers seriesDate posted: February 10, 2008Suggested CitationContact Information
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