As part of the Brown Bag Lunch series, the International Economics Department at the Graduate Institute is pleased to invite you to a public talk given by Yue Zhou, PhD student in International Economics.

VAT, Sales Tax, and Informality: Does VAT Reform Reduce Informality?

Abstract: Informality is pervasive in developing countries. More than 50 countries adopted value-added tax (VAT) in the last two decades to foster formalization and taxation, but its outcomes and the underlying mechanism are less well understood. This paper systematically studies the impacts of VAT reform on informality by extending a structural model that rationalizes firms’ tax status and the trade pattern. First, I find that replacing cascading sales tax with VAT would encourage formalization of informal firms and enlarge outputs of the formal sector. The positive impacts on informality diminishes if the VAT rate is too high. Then I show that VAT reform would increase the formal sector's profit and income but at the cost of the informal sector. Finally, I show that the formalization can be transmitted through the production chain under VAT. Buyers will formalize when stricter enforcement is implemented to the informal suppliers, but not the other way around.