Is consumption-Laffer curve hump-shaped? The VAT evasion channel

Abstract

Purpose

The purpose of this paper is to show a standard RBC model, when augmented with a VAT evasion channel, where evasion depends on the consumption tax rate, can produce a hump-shaped consumption-Laffer curve.

Design/methodology/approach

The methodology is in the spirit of modern quantitative macroeconomic literature.

Findings

The model with VAT evasion can generate a peaking consumption tax revenue curve, which is a little discussed result in the taxation literature.

Research limitations/implications

The paper contributes to the public finance literature by providing evidence for the importance of the evasion mechanism, while at the same time adding to the debate about the existence of a peak tax rate for consumption tax revenue.

Practical implications

Contrary to popular belief, raising VAT rate as a cheap way (being a tax on demand) to finance government expenditure, is still not a free lunch, and raising the rate, especially in a country with substantial VAT evasion, quickly leads to a drop in the revenue associated with that category.

Originality/value

This is the first study that provides a tractable model of VAT evasion, and a setup where consumption tax revenue curve is peaking.

Citation

Vasilev, A. (2018), "Is consumption-Laffer curve hump-shaped? The VAT evasion channel", Journal of Economic Studies, Vol. 45 No. 3, pp. 598-609. https://doi.org/10.1108/JES-05-2017-0115