A central question for a country's economic development is how to improve the state's ability to raise revenues domestically in the presence of widespread tax evasion (Besley and Persson, 2009). In this context, the Value Added Tax (VAT) has become one of the most important instruments of revenue mobilization in the developing world. In principle, a VAT has several advantages in terms of tax compliance compared to other tax instruments, as it incentivizes accurate reporting of sales and purchases. Firms are essentially taxed on the difference between their sales and the cost of their inputs, and they must report both to the tax authority and keep a paper trail of the transactions (i.e., receipts) in their books. To minimize tax liability, firms would like to under-report sales, but to over-report inputs. This asymmetry should limit the room for "collusive evasion" in the case of business-to-business transactions, i.e., collusion between firms in misreporting transaction values. The existence of a paper trail should also deter "unilateral evasion", i.e., firms unilaterally misreporting transaction values, as the tax authority could crosscheck the values reported by a firm with records from third parties (i.e., suppliers and clients).
Pomeranz (2015) provided empirical evidence showing the importance of these properties of the VAT for tax compliance. Yet, in practice, limited enforcement capacity may prevent tax authorities from efficiently cross-checking what firms report against records from third parties, and thus limit unilateral evasion. To address this concern, several countries around the world, including Rwanda, have mandated the use of Electronic Billing Machines (EBMs), which generate a unique "hard-to-tamper-with" receipt for each transaction and send information on each receipt to the tax authority on a regular basis (e.g., in real time or daily). This technology limits the ability of firms to unilaterally misreport a transaction once a receipt for that transaction has been issued, which can be particularly effective for business-to-business transactions as firms have an incentive to ask for receipts for their input transactions (to decrease their tax liability). Eissa and Zeitlin (2015) show the roll-out of EBMs improved compliance in Rwanda.
However, final consumers do not have similar incentives to ask for receipts, so firms can more easily under-report sales to final consumers, an issue that can persist with EBMs if firms do not actually issue receipts to final consumers. Eissa and Zeitlin (2015) also document that firms failed to issue receipts in a large share of a sample of retail transactions made after the EBM roll-out in Rwanda. One potential policy response is to incentivize consumers to ask for receipts, e.g., with lotteries and tax rebates based on consumers’ receipts. Naritomi (AER forthcoming) provides evidence that such policies can effectively reduce the under-reporting of sales to final consumers. However, these policies can be quite expensive, as incentives have to be paid to all consumers.
Alternatively, governments can address this "last-mile" problem of the VAT with audits and related enforcement strategies at the retail level. In this light, Electronic Billing Machines can be seen as a technology that changes the cost of such enforcement strategies: by requiring firms to keep electronic accounts, they make it readily visible whether a firm is planning to declare revenue associated with a given transaction. This suggests that tax authorities can combat tax evasion by auditing firms' use of EBMs through unannounced visits, in which staff of the tax authority stop consumers leaving a store, check whether they were issued a valid EBM receipt, and apply penalties in case of non-compliance.
This study investigates the impact of such an enforcement strategy through a randomized control trial conducted in collaboration with the Rwandan Revenue Authority (RRA) with the aim of answering three questions:
1. What are the impacts of such an enforcement strategy on retailers' issuance of receipts, reporting of sales, and tax liability?
2. What is the impact of the associated increase in retailers' tax compliance on prices, i.e., what is the incidence on retailers vs. consumers?
3. Do firms' responses to audit risk depend on the audit risk of their competitors, i.e., does the impact of the treatment vary with the rate of treatment saturation among competitors?
The answer to the first question will allow us to evaluate the effectiveness of a policy to address the last-mile problem that is complementary to the EBM technology. The second question is important conceptually to understand the effects of enforcement policies and the possible public support for these policies. There is very little evidence on the incidence of tax evasion (Kopczuk et al., 2016). To the extent that the evasion rents are broadly shared with consumers (through lower retail prices), policies aiming to reduce tax evasion may face little support in the public as the cost of such policies (higher retail prices) may be more salient than their possible benefits (possible gains from increased government revenue). The answer to the third question is important to shed light on the mechanisms behind our answer to the second question. The ability of retailers to pass the costs associated with stronger tax enforcement onto prices likely depends on the competitive structure of the market in which they operate (e.g., monopoly, monopolistic competition, perfect competition) and on whether their competitors are also subject to the same costs. This is important because experimental enforcement interventions, such as the one we study, often focus on a subset of firms (e.g., often treat competing firms differently) but hope to inform the effect that such interventions could have when applied more broadly (e.g., treating all competing firms similarly).
In practice, this project evaluates the impact of an RRA initiative to send auditors to make surprise visits to retail firms in Kigali over a 10-month period and to observe whether ordinary consumers of those retailers are receiving receipts for their transaction. The evaluation combines innovations in measurement -- we combine VAT declarations with both real-time data on the universe of transactions reported through EBMs and receipt outcomes from natural transactions conducted by "mystery shoppers" sent to control and treatment firms throughout the study period for research purposes only -- with two dimensions of experimental variation: at the firm level, firms are assigned to (zero or) variable frequencies of audit, and across firms, we vary the saturation of the treatment among economic competitors to study strategic complementarities.