Production and Evasion Responses with Limited State Capacity
Working paper Production and evasion responses with limited state capacity Evidence from major tax reforms in India David R. Agrawal Laura Zimmermann June 2019 When citing this paper, please use the title and the following reference number: S-89411-INC-1 Production and Evasion Responses with Limited State Capacity - Evidence from Major Tax Reforms in India David R. Agrawal, University of Kentucky Laura Zimmermann, University of Georgia∗ This Version: June 2019 Abstract Taxes on transactions are a common way of raising tax revenue, mostly in the form of a sales tax or a value-added tax (VAT). We analyze the effect of a switch from a sales tax to a VAT on output and tax evasion. States in India gradually transitioned from a sales tax to a VAT system. We digitize and harmonize all of India's state-level consumption tax systems, which feature tax rates on hundreds of categories of goods that vary across states. Exploiting state- and product-specific tax variation and the staggered implementation of VAT across states, we show that by five years after the reform, gross sales increase by 16%. This increase in output is a result of the VAT lowering tax rates and reducing distortionary effects of double taxation. Furthermore, in a sample of relatively large manufacturing firms, we find limited evidence of bunching at registration thresholds indicating limited tax evasion. Our study has implications for India's more recent reforms aimed at simplifying the tax law and for the consequences of a similar move in other countries. Keywords: value added tax, sales tax, production efficiency, evasion, bunching JEL: Codes: H21, H25, H26, H71, O17, O23 ∗Contact information: Agrawal: University of Kentucky, Martin School of Public Policy and Admin- istration and Department of Economics, 433 Patterson Office Tower, Lexington, KY 40506-0027.
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