IDEAS home Printed from https://ideas.repec.org/p/iis/dispap/iiisdp323.html
   My bibliography  Save this paper

Tariffs Versus VAT in the Presence of Heterogeneous Firms and an Informal Sector

Author

Listed:
  • Ronald Davies

    (University College Dublin, Institute for International Integration Studies, Trinity College Dublin)

  • Louren Paz

    (Syracuse University)

Abstract

The debate over the use of tariffs or value added taxes in developing countries has focused on the difficulty of collecting VAT from the informal sector of the economy. This paper contributes by considering this issue with heterogeneous firms and endogenous entry. This yields two new results. First, a cut in the tariff in and of itself can reduce the size of the informal sector. Second, the imposition of a VAT need not increase the number of informal firms. In fact, for many parameterizations of the model, higher VAT reduces informality. Despite this, whether a revenue neutral shift from tariffs to VAT increases or decreases welfare depends on the parametrization. Therefore while this move may be welfare improving in some cases, it is not a one-size fits all policy.

Suggested Citation

  • Ronald Davies & Louren Paz, 2010. "Tariffs Versus VAT in the Presence of Heterogeneous Firms and an Informal Sector," The Institute for International Integration Studies Discussion Paper Series iiisdp323, IIIS, revised Mar 2010.
    • Handle: RePEc:iis:dispap:iiisdp323
    as

    Download full text from publisher

    File URL: https://www.tcd.ie/triss/assets/PDFs/iiis/iiisdp323.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Robin Boadway & Motohiro Sato, 2009. "Optimal Tax Design and Enforcement with an Informal Sector," American Economic Journal: Economic Policy, American Economic Association, vol. 1(1), pages 1-27, February.
    2. Keen, Michael & Ligthart, Jenny E., 2002. "Coordinating tariff reduction and domestic tax reform," Journal of International Economics, Elsevier, vol. 56(2), pages 489-507, March.
    3. Ronald B. Davies & Carsten Eckel, 2010. "Tax Competition for Heterogeneous Firms with Endogenous Entry," American Economic Journal: Economic Policy, American Economic Association, vol. 2(1), pages 77-102, February.
    4. John Piggott & John Whalley, 2001. "VAT Base Broadening, Self Supply, and the Informal Sector," American Economic Review, American Economic Association, vol. 91(4), pages 1084-1094, September.
    5. Friedrich Schneider & Dominik Enste, 1999. "Shadow Economies Around the World - Size, Causes, and Consequences," CESifo Working Paper Series 196, CESifo.
    6. Ellingsen, Tore & Warneryd, Karl, 1999. "Foreign Direct Investment and the Political Economy of Protection," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(2), pages 357-379, May.
    7. Flam, Harry & Helpman, Elhanan, 1987. "Industrial policy under monopolistic competition," Journal of International Economics, Elsevier, vol. 22(1-2), pages 79-102, February.
    8. Knud MUNK, 2008. "On the Use of Border Taxes in Developing Countries," EcoMod2008 23800093, EcoMod.
    9. Elhanan Helpman & Marc J. Melitz & Stephen R. Yeaple, 2004. "Export Versus FDI with Heterogeneous Firms," American Economic Review, American Economic Association, vol. 94(1), pages 300-316, March.
    10. Jørgensen, Jan G. & Schröder, Philipp J.H., 2008. "Fixed export cost heterogeneity, trade and welfare," European Economic Review, Elsevier, vol. 52(7), pages 1256-1274, October.
    11. Emran, M. Shahe & Stiglitz, Joseph E., 2005. "On selective indirect tax reform in developing countries," Journal of Public Economics, Elsevier, vol. 89(4), pages 599-623, April.
    12. Chor, Davin, 2009. "Subsidies for FDI: Implications from a model with heterogeneous firms," Journal of International Economics, Elsevier, vol. 78(1), pages 113-125, June.
    13. Céline DE QUATREBARBES & Luc SAVARD & Dorothée BOCCANFUSO, 2011. "Can the removal of VAT Exemptions support the Poor? The Case of Niger," Working Papers 201106, CERDI.
    14. Baunsgaard, Thomas & Keen, Michael, 2010. "Tax revenue and (or?) trade liberalization," Journal of Public Economics, Elsevier, vol. 94(9-10), pages 563-577, October.
    15. Knud Jørgen Munk, 2006. "On the Rationale for the Use of Border Taxes in Developing Countries," Economics Working Papers 2006-12, Department of Economics and Business Economics, Aarhus University.
    16. Matthew T. Cole (University College Dublin) Ronald B. Davies (University College Dublin), 2009. "Optimal Tariffs, Tariff Jumping, and Heterogeneous Firms," The Institute for International Integration Studies Discussion Paper Series iiisdp302, IIIS.
    17. Michael Keen, 2009. "What Do (and Don't) We Know about the Value Added Tax? A Review of Richard M. Bird and Pierre-Pascal Gendron's The VAT in Developing and Transitional Countries," Journal of Economic Literature, American Economic Association, vol. 47(1), pages 159-170, March.
    18. Krugman, Paul R., 1979. "Increasing returns, monopolistic competition, and international trade," Journal of International Economics, Elsevier, vol. 9(4), pages 469-479, November.
    19. Bird,Richard & Gendron,Pierre-Pascal, 2011. "The VAT in Developing and Transitional Countries," Cambridge Books, Cambridge University Press, number 9781107401440.
    20. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    21. Gatti, Roberta & Honorati, Maddalena, 2007. "Informality among Formal Firms: Firm-level, Cross-country Evidence on Tax Compliance and Access to Credit," CEPR Discussion Papers 6597, C.E.P.R. Discussion Papers.
    22. Keen, Michael, 2008. "VAT, tariffs, and withholding: Border taxes and informality in developing countries," Journal of Public Economics, Elsevier, vol. 92(10-11), pages 1892-1906, October.
    23. Guillermo E. Perry & William F. Maloney & Omar S. Arias & Pablo Fajnzylber & Andrew D. Mason & Jaime Saavedra-Chanduvi, 2007. "Informality : Exit and Exclusion," World Bank Publications - Books, The World Bank Group, number 6730.
    24. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March.
    25. Matthew T Cole, 2009. "The Choice of Modeling Firm Heterogeneity and Trade Restrictions," Working Papers 200920, School of Economics, University College Dublin.
    26. Piermartini, Roberta, 2004. "The role of export taxes in the field of primary commodities," WTO Discussion Papers 4, World Trade Organization (WTO), Economic Research and Statistics Division.
    27. Bird,Richard & Gendron,Pierre-Pascal, 2007. "The VAT in Developing and Transitional Countries," Cambridge Books, Cambridge University Press, number 9780521877657.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Dennis Becker, 2018. "Heterogeneous firms and informality: the effects of trade liberalization on labour markets," Oxford Economic Papers, Oxford University Press, vol. 70(1), pages 47-72.
    2. Bauer, Christian & Davies, Ronald B. & Haufler, Andreas, 2014. "Economic integration and the optimal corporate tax structure with heterogeneous firms," Journal of Public Economics, Elsevier, vol. 110(C), pages 42-56.
    3. Barbara Annicchiarico & Claudio Cesaroni, 2018. "Tax reforms and the underground economy: a simulation-based analysis," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 25(2), pages 458-518, April.
    4. Creane, Anthony & Jeitschko, Thomas D., 2016. "Exporting to bypass weak institutions," European Economic Review, Elsevier, vol. 83(C), pages 185-197.
    5. Panos Hatzipanayotou & Sajal Lahiri & Michael Michael, 2011. "Trade and domestic tax reforms in the presence of a public good and different neutrality conditions," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 18(3), pages 273-290, June.
    6. Kowsar Yousefi & Mohammad Vesal, 2023. "The Double Dividend of a Joint Tariff and VAT Reform: Evidence from Iran," The World Bank Economic Review, World Bank, vol. 37(2), pages 331-349.
    7. Michael Michael & Panos Hatzipanayotou, 2013. "Pollution and reforms of domestic and trade taxes towards uniformity," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 20(5), pages 753-768, October.
    8. Bognetti, Giuseppe & Santoni, Michele, 2016. "Increasing the substitution elasticity can improve VAT compliance and social welfare," Economic Modelling, Elsevier, vol. 58(C), pages 293-307.
    9. Paz, Lourenco, 2012. "The impacts of trade liberalization on informal labor markets: an evaluation of the Brazilian case," MPRA Paper 38858, University Library of Munich, Germany.
    10. Paz, Lourenço S., 2014. "The impacts of trade liberalization on informal labor markets: A theoretical and empirical evaluation of the Brazilian case," Journal of International Economics, Elsevier, vol. 92(2), pages 330-348.
    11. Fabio Antoniou & Panos Hatzipanayotou & Michael S. Michael & Nikos Tsakiris, 2022. "Tax competition in the presence of environmental spillovers," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 29(3), pages 600-626, June.
    12. Liu, Ailan & Wang, Zhixuan & Zhu, Pengcheng, 2021. "Does informal economy undermine the effects of China’s aid on its outward foreign direct investment?," International Review of Economics & Finance, Elsevier, vol. 75(C), pages 315-329.
    13. Lourenço S. Paz, 2015. "The welfare impacts of a revenue-neutral switch from tariffs to VAT with intermediate inputs and a VAT threshold," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 24(4), pages 465-498, June.
    14. Caro, Paolo Di & Sacchi, Agnese, 2020. "The heterogeneous effects of labor informality on VAT revenues: Evidence on a developed country," Journal of Macroeconomics, Elsevier, vol. 63(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Lourenço S. Paz, 2015. "The welfare impacts of a revenue-neutral switch from tariffs to VAT with intermediate inputs and a VAT threshold," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 24(4), pages 465-498, June.
    2. Bauer, Christian & Davies, Ronald B. & Haufler, Andreas, 2014. "Economic integration and the optimal corporate tax structure with heterogeneous firms," Journal of Public Economics, Elsevier, vol. 110(C), pages 42-56.
    3. Matthew T. Cole (University College Dublin) Ronald B. Davies (University College Dublin), 2009. "Optimal Tariffs, Tariff Jumping, and Heterogeneous Firms," The Institute for International Integration Studies Discussion Paper Series iiisdp302, IIIS.
    4. Antonio Gómez Gómez-Plana & Pedro Pascual Arzoz, 2011. "Fraude fiscal e IVA en España: incidencia en un modelo de equilibrio general," Hacienda Pública Española / Review of Public Economics, IEF, vol. 199(4), pages 9-52, December.
    5. Michael Keen, 2009. "What Do (and Don't) We Know about the Value Added Tax? A Review of Richard M. Bird and Pierre-Pascal Gendron's The VAT in Developing and Transitional Countries," Journal of Economic Literature, American Economic Association, vol. 47(1), pages 159-170, March.
    6. Christian Hubert Ebeke & Hélène Ehrhart, 2012. "Does VAT reduce the instability of tax revenues?," CERDI Working papers halshs-00617272, HAL.
    7. Christian EBEKE & Hélène EHRHART, 2011. "Does VAT reduce the instability of tax revenues?," Working Papers 201124, CERDI.
    8. Buettner, Thiess & Madzharova, Boryana, 2018. "WTO membership and the shift to consumption taxes," World Development, Elsevier, vol. 108(C), pages 197-218.
    9. Amèvi Rocard Kouwoaye, 2019. "Trade tax reforms and poverty in developing countries: Why do some countries benefit and others lose?," WIDER Working Paper Series wp-2019-66, World Institute for Development Economic Research (UNU-WIDER).
    10. Igor Bagayev & Ronald B. Davies, 2017. "The Impact of Protection on Observed Productivity Distributions," Working Papers 201705, School of Economics, University College Dublin.
    11. Auriol, Emmanuelle & Warlters, Michael, 2012. "The marginal cost of public funds and tax reform in Africa," Journal of Development Economics, Elsevier, vol. 97(1), pages 58-72.
    12. Eduardo Lora & Johanna Fajardo-González, 2016. "Employment and taxes in Latin America: An empirical study of the effects of payroll, corporate income and value-added taxes on labor outcomes," Revista Cuadernos de Economia, Universidad Nacional de Colombia, FCE, CID, vol. 35(Especial ), pages 75-117, January.
    13. Haibara Takumi, 2017. "Indirect Tax Reform in Developing Countries: A Consumption-Neutral Approach," Journal of Globalization and Development, De Gruyter, vol. 8(1), pages 1-11, June.
    14. Cole, Matthew T. & Davies, Ronald B., 2011. "Strategic tariffs, tariff jumping, and heterogeneous firms," European Economic Review, Elsevier, vol. 55(4), pages 480-496, May.
    15. Fikri R. Arrachman & Riatu M. Qibthiyyah, 2018. "The Relationship of VAT Rate and Revenues in the Case of Informality," Economics and Finance in Indonesia, Faculty of Economics and Business, University of Indonesia, vol. 64, pages 73-96, Juni.
    16. Paz, Lourenço S., 2014. "The impacts of trade liberalization on informal labor markets: A theoretical and empirical evaluation of the Brazilian case," Journal of International Economics, Elsevier, vol. 92(2), pages 330-348.
    17. Sokolovska, Olena & Sokolovskyi, Dmytro, 2011. "The effect of tax-tariff reform: evidence from Ukraine," MPRA Paper 42643, University Library of Munich, Germany.
    18. Pflüger, Michael P. & Russek, Stephan, 2010. "Trade and Industrial Policies with Heterogeneous Firms: The Role of Country Asymmetries," IZA Discussion Papers 5387, Institute of Labor Economics (IZA).
    19. Jenny Ligthart & Gerard C. van der Meijden, 2010. "Coordinated Tax-Tariff Reforms, Informality, and Welfare Distribution," CESifo Working Paper Series 3107, CESifo.
    20. Michael Pflüger & Stephan Russek, 2011. "Trade and Industrial Policies with Heterogeneous Firms: The Role of Country Asymmetries," Working Papers 094, Bavarian Graduate Program in Economics (BGPE).

    More about this item

    Keywords

    Heterogeneous firms; Tariffs; VAT; Informal firms;
    All these keywords.

    JEL classification:

    • F1 - International Economics - - Trade
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:iis:dispap:iiisdp323. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Maeve (email available below). General contact details of provider: https://edirc.repec.org/data/cetcdie.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.