US VAT solves – noncompliance is due to preexisting government corruption

8. Concluding remarks Economists believe that institutions related to state and fiscal capacity are important for tax compliance and revenue, and that tax revenues in turn can yield improvements in state and fiscal capacity generating a positive feedback loop for economic development. That said, we lack reliable, comparable estimates which speak to the importance of non-compliance in explaining differences in revenue across countries. This paper provides a new method of estimating value added tax revenues lost due to domestic non-compliance using aggregate time series data available for a large set of countries, and shows how estimated non-compliance depends on state and civil society institutions. It relies on the insight that, because VAT compliance tends to be higher at borders, the correlation between VAT revenue performance (i.e. C-efficiency) and shares of imports in final consumption is informative about the extent of VAT non-compliance on domestic production. Our results suggest that domestic compliance varies widely across countries. Domestic compliance is especially low in countries with low measures of control of corruption and in countries in Africa, Asia, Latin America, and Eastern Europe. In contrast, in countries with higher measured institutional quality and in those countries in Northern Europe, domestic compliance is much higher. As well, we find that countries which import larger shares of imports in final consumption tend to have higher aggregate compliance due to controls at international borders. A simple thought experiment provides a back of the envelope calculation for the magnitude of this mechanism. Suppose that all countries had a domestic compliance gap lowered to the 10th percentile of (all) domestic compliance gaps if their observed domestic compliance gap were higher than the 10th percentile, and constant if it were lower. Holding actual observed consumption and import levels constant, this would reduce the amount of global tax revenue lost by 23% in 2016.40 While our results speak to the importance of border controls in promoting fiscal capacity, we abstract from welfare effects in our analysis. A formal cost-benefit analysis of VAT taxes versus trade taxes may offer normative results. However, we believe that this first bit of evidence on using trade and VAT performance to understand domestic non-compliance is a first step in that direction.