VAT Compliance Incentives

Abstract

VAT compliance incentives are here studied through a game theoretical approach. Agents are explicitly assumed selfish and risk neutral. Compliance or evasion are a simple rational choice given tax parameters and the probability of audit. VAT evasion is a collusive conduct between the two counterparts of the transaction. While under no-audit the counterparts are generally keen to evade, even under a weak probability of audit they are both keen to comply. Therefore, they can form a coalition against the Tax Authority that is then forced to large and costly auditing. Under tax allowances to buyer specific invoiced expenses and no audit, this coalition breaks because the buyer prefers to comply and the seller to evade.
In this work we compute the thresholds for tax policy parameters for the private coalition to be willing to comply as a determined trade-off versus auditing.
The paper also enlighten the importance of the ratio costs/output values in the transaction. The larger the previous costs in a production chain, the smaller is the gain from VAT evasion. Therefore, for each fiscal parameter set, we can compute the threshold costs/output under which evasion is very likely and where therefore tax allowances can lead to compliance and, even if costly, they can lead to tax revenue increase.
Although the policies are at work in some economies, we try to establish a method for tax design, able to make compliance the "dominant strategy", satisfying the "outside option" constraints against the various types of evasion, even in absence of audit and sanctions. The theoretical results derived here can be easily applied to real data.

Keywords: Tax evasion, Tax design, Tax compliance, Tax fraud, VAT, Audit, Tax incentives, Fiscal Policy, Public Economics, Public Finance, Tax Induced, Mixed strategies game, Bayesian game.

JEL Classification: D81, D82, H21, H25, H26, H3.