Tax Enforcement and Young Formal Businesses in Shocks: Microeconomic Evidence for the Ecuadorian Case

While tax revenues are important for the government, they are also intimately related to agentbehavior when there is margin to underreport. Moreover, implementing appropriate tax policies isa complex problem since the enforcer does not know the real profits agents make, and because such policy must be well targeted to improve the economic environment. And, defining a policy is particularly complex when the economy is in a contractive phase of the cycle, as then tax revenues are certainly endogenous to economic activity and measuring the effect of taxation becomes even more difficult. In this light, this paper provides an investigation into underreporting behavior and how it affects income taxes, both during regular and contractive periods, using disaggregated microeconomic data from a sample of Ecuadorean firms. It is found that there is a tendency to underreport over regular phases of the economic cycle and to shift onto deductible margins during the most recent contractive period. Also, it is seen that experimented, older firms increased their deductible margins on average, while young, newer firms have not. These results serve to see how the pandemic affected firms differentially across groups, indicating the need to implement policies with a focus on young firms and in turn incentivize formal entrepreneurship.,