Tax Rates and Tax Evasion: Evidence from

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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 punishment is 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 M Demand 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
HK-Reported Exports to China
China-reported Imports from HK
Evasion
Noise
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Does Tax Rate Affect Evasion?
HK-Reported Exportsi China-Reported
Importsi Evasion Gapi Noisei ?i
?(Tax Rate)i ?I
H0 ? gt 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 Predictions
Type 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 Examples
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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, min13 and max 135
• standard deviation 10.34

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Direct vs. Indirect Imports/Exports
HK Reported Exports
China Reported Imports

• Entry point for many 3rd country exports
• Indirect exports reported separately

• In theory, Chinese reported imports reflect
  country of origin
• Not always successfully separated (esp. Taiwan)

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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Summary Statistics
Variable Mean Std. Dev.
Gap_Value -0.62 2.43
Gap_Qty -1.06 2.56
Tax Rate (TariffVAT) 36.09 10.34
Direct Export Ratio 0.17 0.23
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Specification
log(Exportk ) - log(Importk ) a ß Taxk ek
But observed imports (Import) are imperfectly
recorded
Importk Importk Misclassified Indirect
Importk
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Recall Tax Rates are Identical for Direct
Indirect Imports
Tax rate uncorrelated with Misclassified Imports
Modeling Assumption Misclassified Indirect
Importk k ?k Importk
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Hence
Importk Importk Misclassified Indirect
Importk (1 k ?k ) Importk
Combining with previous equations, we estimate
log(Exportk ) - log(Importk ) a ß Taxk ek
Evasion Gap
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Summary of Predictions
Sign In Value Regression Sign In Value Regression Sign In Qty Regression Sign In Qty Regression
Tax Avg(Tax) Tax Avg(Tax)
Underreported Prices 0 0 0
Underreported Quantities 0 0
Relabeling
Type of Evasion
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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
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Table 3 Aggregation by Tax Rates
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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 gt ? ? 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 a ß1Taxk ß2Avg(Tax_o)
?k
If mis-labeling exists ß2 lt 0
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Table 4 Evidence of Mis-labeling
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Table 5 Evidence on Quantities
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Robustness Checks

• Controlling for Exemptions
• Exclude indirect export dominated industries
• Results Qualitatively unchanged

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Table 6 Controlling for Exemptions
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Table 7 First Differences 1997-98
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Flexible Functional Form
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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?