Working Paper 101

It is well documented in the literature that developing countries raise less tax revenue as a share of their economy than their developed counterparts. Part of this gap can be explained by the relatively higher tax evasion in the former. Recent literature shows that increasing the availability of information reduces evasion, by increasing the probability of detection. However, there is little evidence to show how tax evasion responds to changes in tax rates.

Using highly disaggregated trade data, we show that there is more tax evasion when tax rates increase. However, this relationship only holds when we use the de facto effective tax rate, rather than the de jure effective tax rate. We also find that evasion takes place through under-reporting of the value of imports, as well as mislabelling highly-taxed products as similar lower-taxed products. Finally, we show that when trade costs are ignored, the level of evasion is underestimated; the degree of underestimation in the elasticity estimate depends on the way the trade cost is included in the estimation.

Authors

Andualem T. Mengistu

Andualem Mengistu is a Technical Advisor at the IMF Fiscal Affairs Department and Director at the Macroeconomic Division at the Ethiopian Development Research Institute.

Kiflu G. Molla

Giulia Mascagni

Giulia Mascagni is a Research Fellow at the Institute of Development Studies and Executive Director of the ICTD. Her main area of work is taxation, but she also has research interest in public finance, evaluation of public policy, and aid effectiveness. She is an economist by training, holding a PhD in Economics from the University of Sussex. Her main geographical interest lies in African countries, with a particular focus on Ethiopia and Rwanda.
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