Production vs Revenue Efficiency with Limited Tax Capacity: Theory and Evidence from Pakistan

44 Pages Posted: 8 Nov 2013

See all articles by Anne Brockmeyer

Anne Brockmeyer

World Bank

Henrik Kleven

London School of Economics & Political Science (LSE) - Suntory and Toyota International Centres for Economics and Related Disciplines (STICERD)

Johannes Spinnewijn

London School of Economics & Political Science (LSE)

Mazhar Waseem

London School of Economics & Political Science (LSE)

Date Written: November 2013

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.

Suggested Citation

Brockmeyer, Anne and Kleven, Henrik and Spinnewijn, Johannes and Waseem, Mazhar, Production vs Revenue Efficiency with Limited Tax Capacity: Theory and Evidence from Pakistan (November 2013). CEPR Discussion Paper No. DP9717. Available at SSRN: https://ssrn.com/abstract=2351324

Anne Brockmeyer

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Henrik Kleven

London School of Economics & Political Science (LSE) - Suntory and Toyota International Centres for Economics and Related Disciplines (STICERD) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Johannes Spinnewijn

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
00 44 (0) 20 7955 7022 (Phone)

HOME PAGE: http://econ.lse.ac.uk/staff/spinnewijn_johannes/

Mazhar Waseem

London School of Economics & Political Science (LSE) ( email )

Department of Economics
Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://personal.lse.ac.uk/waseem/

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