Tax evasion and tax reform in a low income economy : general equilibrium estimates for Madagascar

Madagascar's weak administrative system and complex tax structure (with many exemptions) have led to tax evasion and smuggling. The authors compare Madagascar's fiscal system with that of other low-income countries, noting its greater reliance on distortionary taxes. Using a 10-sector model and general equilibrium calculations, they estimate revenue losses from exemptions, tax evasion, and smuggling for three important instruments: import duties, value added taxes, and excise taxes. Next they calculate the welfare gain that would result from less distortionary tax structures. Simulation results suggest that the excess burden of taxes would be greatly reduced if Madagascar moved closer to a tax system with uniform rates across sector and instruments. Assuming that the uniform tax would be imposed only in sectors in which tax collection is now positive, simulations suggest that a uniform tax rate of 6 percent across instruments would be enough to raise the same revenues collected under the current structure. Moreover, lower bound estimates indicate the the excess burden of taxation would be reduced by moving toward uniformity of about 5 percent of the tax base.