tax rates and tax evasion: evidence from “missing imports” in china raymond fisman columbia...
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Tax Rates and Tax Evasion: Evidence from “Missing Imports” in China
Raymond FismanColumbia University
Shang-Jin WeiIMF and NBER
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Plan of the Presentation
• Motivation & Basic Methodology
• Data
• Basic Results
• Economic Interpretation
• Robustness Checks and Extensions
• Conclusions
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Public Finance Theory: The Role of Evasion
• Often, collection assumed to be perfect
• Correlates of evasion:-punishment (cost)-tax rate (benefit)
• How important is this effect?
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Theory: Rate-Evasion Relationship may be Counterintuitive
Model: Allingham & Sandmo (1972)Predicted Relationship: Depends on U’’’(w)
Model: Yitzhaki (1972)Predicted Relationship: Positive if punishmentis a function of evaded taxes
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How much evasion is there? Measuring what we cannot observe
1. Discrepancy in Macro-variables-Difference between national income and product accounts-Ratio of currency to M2
2. U.S. Taxpayer Compliance Measurement Program (TCMP)
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Measuring Evasion: Previous Work
Method Approach/
Examples
Problems
Inference from obs. quantities
1. M Demand
2. I – C
-based on dubious assumptions
-measures evasion level (not sensitivity)
U.S. TCMP Intensive Audit
-Rate-Evasion relationship not separable from income effect
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Our Approach
Without Evasion (and measurement error):
Exports from Hong Kong to China
Imports from China to Hong Kong
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In reality…
Noise
Evasion
HK-Reported Exports to China
China-reported Imports from HK
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Does Tax Rate Affect Evasion?
HK-Reported Exportsi – China-Reported Importsi
= ‘Evasion Gap’i + Noisei
= i + *(Tax Rate)i + I
H0: > 0
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Predictions: Types of Evasion
• Smuggling that bypasses Hong Kong: Not detected by analyses
• Under-reporting prices
• Under-reporting quantities
• ‘Mislabeling’ goods
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Summary of PredictionsType of Evasion Predictions
Under-reporting per unit value
Tax rate positively correlated with evasion gap in values
Under-reporting quantities
Tax rate positively correlated with evasion gap in values and quantities
‘Mislabeling’ goods Tax rate of closely related goods negatively correlated with evasion gap in values and quantities
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Plan of the Presentation
• Motivation & Basic Methodology
• Data
• Basic Results
• Economic Interpretation
• Robustness Checks and Extensions
• Conclusions
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Trade Flow Data: WITS(World Integrated Trade Solutions)
• Derived from UN Comtrade
• 6-digit Harmonized Commodity Description and Coding System (HS)
• Available since 1996
• Data Utilized: 1998 (little year-to-year variation in tax rates) (and later also 1997)
• Both Value and Quantity data available
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Industry-level data: Examples540210 High tenacity yarn of nylon or other polyamides540220 High tenacity yarn of polyesters540231 Textured yarn :-- Of nylon or other polyamides, measuring per single yarn not more than 50 tex540232 Textured yarn :-- Of nylon or other polyamides, measuring per single yarn more than 50 tex540233 Textured yarn :-- Of polyesters540239 Textured yarn :-- Other
291211 Acyclic aldehydes without other oxygen function :-- Methanal (formaldehyde)291212 Acyclic aldehydes without other oxygen function :-- Ethanal (acetaldehyde)291213 Acyclic aldehydes without other oxygen function :-- Butanal (butyraldehyde, normal isomer)291219 Acyclic aldehydes without other oxygen function :-- Other291221 Cyclic aldehydes without other oxygen function :-- Benzaldehyde291229 Cyclic aldehydes without other oxygen function :-- Other
010111 Horses :-- Pure-bred breeding animals010119 Horses :-- Other010120 Asses, mules and hinnies
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Tax Rate on Product k
• = Tariff rate on Product k + VAT on k
• In 1998, across 8 digit categories
• Mean = 36, min=13 and max =135
• standard deviation = 10.34
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Direct vs. Indirect Imports/Exports
• Entry point for many 3rd country exports
• Indirect exports reported separately
HK Reported Exports
• In theory, Chinese reported imports reflect country of origin
• Not always successfully separated (esp. Taiwan)
China Reported Imports
Key Fact: Tax Rates are Identical for Direct & Indirect Imports
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Evasion Gap Defined
Gap_Value = log(Export_Value) - log(Import_Value)
Gap_Qty = log(Export_Qty) - log(Import_Qty)
*All Export Figures reflect Direct Exports only
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Tax Rate Data: WITS
• Derived from UNCTAD TRAINS (Trade Analysis and Information System) Database
• Tariff and VAT rates at the 8-digit level• No within-variation for almost all 6-digit
industries: analysis restricted to this subsample• TAX = Tariff + VAT• Taxes on similar goods: Tax rate of all other
goods in 4-digit class
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Variable Mean Std. Dev.
Gap_Value -0.62 2.43
Gap_Qty -1.06 2.56
Tax Rate (Tariff+VAT)
36.09 10.34
Direct Export Ratio
0.17 0.23
Summary Statistics
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Specification
log(Exportk ) - log(Importk )
= α + β Taxk + εk
Import*k = Importk + Misclassified Indirect Importk
But observed imports (Import*) are imperfectly recorded:
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Modeling Assumption:
Misclassified Indirect Importk = k k Importk
Recall: Tax Rates are Identical for Direct & Indirect Imports
Tax rate uncorrelated with Misclassified Imports
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Import*k = Importk + Misclassified Indirect Importk
= (1+ k k ) Importk
log(Exportk ) - log(Import*k )= α* + β Taxk + ek
Hence:
Combining with previous equations, we estimate:
Evasion Gap
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Summary of Predictions
Sign In Value Regression
Sign In Qty Regression
Tax Avg(Tax) Tax Avg(Tax)
Underreported Prices
+ 0 0 0
Underreported Quantities
+ 0 + 0
Relabeling + – + –
Typ
e of
Eva
sion
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Tax Rates and Tax Evasion
• Motivation & Basic Methodology
• Data
• Specification
• Results and Interpretations
• Extensions
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Table 2: Tax Rate and Evasion
Dep.var.=evasion (1) (7)
Tax rate 2.82 (0.78) 3.44 (1.02)
Excluding outliers no yes
Excluding obs.Lacking quantities
no yes
Excluding obs.Lacking similar products.
no yes
#obs./ adj. R2 2043 / 0.015 1165 / 0.025
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Table 3: Aggregation by Tax Rates
Dep.var.=Evasion (1) (2)
Tax Rate 3.10 3.47
(0.99) (0.98)
Method of aggregation mean median
Weighted OLS yes yes
#obs./ adj. R2 44/0.26 44/0.34
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Economic Interpretation of the Estimate
• Let M = reported imports; X= true imports.
• M = X - Evasion
• Evasion = constant + Tax rate + noise
• dlog(M)/d Tax = dlog(X)/dTax -
• | dlog(M) / d Tax | > 3
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Economic Interpretation (continued)
• Any tax rate above 33.3% is on the wrong side of the Laffer curve: a reduction in rate can result in an increase, rather than decrease, in revenue collection.
• The avg. tax rate in China was 36% (in 1998).• So many rates were too high even from a revenue
point of view.
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Effect of mis-labeling: increasing taxes on similar goods
reduces evasion
Gap_Valuek = α + β1*Taxk
+ β2*Avg(Tax_o) + υk
If mis-labeling exists: β2 < 0
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Table 4: Evidence of Mis-labeling
Dep. Var.=Evasion (2) (7)
Own Tax rate 6.32 (1.77) 7.20(1.39)
Tax Rate on ‘Similar’Products
-3.57 (1.70) -4.09 (1.47)
Excluding outliers? no yes
Excluding productsW/o Quan. Info.?
no yes
#obs. / adj. R2 1760 / 0.016 1165 / 0.029
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Table 5: Evidence on Quantities
Dep. Var.=Evasion in Quantity
(5) (6)
Own Tax rate 7.59 (2.08) 8.11(1.62)
Tax Rate on ‘Similar’Products
-7.40 (2.07) -8.13 (3.50)
Excluding outliers? no yes
Excluding productsW/o Quan. Info.?
yes yes
#obs. / adj. R2 1191 / 0.011 1145 / 0.017
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Robustness Checks
1. Controlling for Exemptions
2. Exclude ‘indirect export dominated’ industries
Results: Qualitatively unchanged
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Table 6: Controlling for Exemptions
Evasion in value Evasion in Quantity
Own Tax Rate 6.03 (1.84) 6.97 (2.06)
Tax Rate onSimilar Products
-3.04 (1.77) -6.57 (2.09)
Exemption Ratio -0.72 (0.26) -1.02 (0.32)
# obs. / adj. R2 1639 / 0.028 1104 / 0.026
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Table 7: First Differences 1997-98
Change inevasion invalue
Change inevasion inquantity
Change in own tax 3.90 (1.92) 5.43 (2.77)
Change in tax on similarproducts
-1.89 (2.01) 3.12 (3.08)
#obs. / adj R2 1574 / 0.006 1045 / 0.004
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Flexible Functional Form
Tax –1st quartile -0.97 (3.56) -0.10 (4.96)
Tax –2nd quartile 0.77(4.47) -5.26 (4.72)
Tax –3rd quartile 7.41(3.04) 10.50 (3.98)
Tax –4th quartile 1.59 (1.20) 5.51 (2.65)
Tax on “similar” -3.69 (1.79)
#obs / adj. R2 2043 / 0.017 1760 / 0.022
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Conclusions
• Evasion is highly correlated with tax rate• ‘Above average’ tax rates cause most
evasion• Evasion correlated with tax rates is
primarily:- under-reporting the unit value
• - mis-reporting goods as lower-taxed types
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Future Work
• Apply the same technique to a broader set of countries
• -How does tariff dispersion affect evasion?
• -Is this an objective measure of corruption?