Dodging the taxman: Firm misreporting and limits to tax enforcement

This seminar will be presented by Dina Pomeranz (Harvard Business School) , joint with Paul Carrillo and Monica Singhal.

Reducing tax evasion is a key priority for many governments, particularly in developing countries. A growing literature has argued that the use of third party information to verify taxpayer self-reports is critical for tax enforcement and the growth of state capacity. However, there may be limits to the effectiveness of third party information if  taxpayers can make offsetting adjustments on less verifiable margins.

We present a simple framework to demonstrate the conditions under which this will occur and provide strong empirical evidence for such behavior by exploiting a natural experiment in Ecuador.

We find that when firms are notified by the tax authority about detected revenue discrepancies on previously filed corporate income tax returns, they increase reported revenues, matching the third party estimate when provided. Firms also increase reported costs by 96 cents for every dollar of revenue adjustment, resulting in minor increases in total tax collection.