Using computerized information to enforce VAT: Evidence from Pakistan

Abstract

I test the efficacy of VAT’s in-built third-party information trail, together with electronic filing, to deter tax evasion in a low state capacity environment. Using a reform which utilizes information beyond the VAT trail and authorizes a computerized risk analysis system to accept or reject tax credits in real time, my difference-in-differences estimates show that claims declined by 50%. Based on firm heterogeneity, the response ranges from 30%–90%. Approximately 10% of treated firms were fake, created for missing trader fraud. The lower bound estimate of increase in net VAT collection at the country level is 10%. I find that traditional VAT enforcement mechanisms of cross-matching, audit and recovery fail to deter evasion in developing countries but a risk-based real-time enforcement system is effective.