Monday, October 15, 2018
Anne Brockmeyer (World Bank) presents Taxation, Information, and Withholding: Evidence from Costa Rica (with Marco Hernandez (World Bank)) at UC-Berkeley today as part of its Robert D. Burch Center for Tax Policy and Public Finance Seminar Series:
This paper studies the compliance effect of tax withholding on firms, which is commonly used in developing countries. While a growing literature argues that third-party reporting of tax liabilities is a key mechanism for ensuring tax compliance, and a reason why tax capacity grows along the development path, the literature has ignored the fact that third-party reporting is often associated with tax withholding. Withholding is irrelevant if the tax withheld is fully credited against a taxpayer’s liability, but can increase compliance in the presence of costly reclaim, low salience of enforcement or extensive margin compliance gaps.
To demonstrate this empirically, we exploit a ten-year panel of income and sales tax records for 400,000 firms and over 20 million third-party information and withholding reports from Costa Rica. We first document the anatomy of compliance, finding that firms are relatively compliant with thirdparty reports on the extensive, intensive and payment margin. When subject to third-party reporting for the first time, firms’ reported taxable income increases by up to 50%. We then isolate the effect of withholding by exploiting a withholding rate increase that left reporting requirements unchanged. A doubling of the withholding rate lead to a 33% increase in sales tax payment among treated firms and an 8% increase in aggregate sales tax revenue. The mechanisms are a default payment effect and reduced misreporting. The large compliance impact of withholding rationalizes its widespread use in developing countries.