Dodging the Taxman: Firm Misreporting and Limits to Tax Enforcement

TLDR

Governments prioritize reducing tax evasion, but enforcement is limited when authorities lack credible enforcement and taxpayers offset discrepancies on other margins, despite evidence that verifying reports against third‑party data is critical. We exploit a policy intervention in which Ecuadorian firms were notified about detected revenue discrepancies. Most firms did not respond, while those that did matched the discrepancy in revenue but raised costs by 96 cents per dollar of adjustment, yielding only modest tax collection gains. JEL codes: D22, H25, H26, O23.

Abstract

Reducing tax evasion is a priority for many governments. A growing literature argues that verifying taxpayer reports against third-party information is critical for tax collection. However, effectiveness can be limited when tax authorities face constraints to credible enforcement and taxpayers make offsetting adjustments on other margins. We exploit a policy intervention in which Ecuadorian firms were notified about detected revenue discrepancies. Most firms simply failed to respond. Firms that responded increased reported revenue, matching the discrepancy amount when provided. However, they also increased reported costs by 96 cents per dollar of revenue adjustment, resulting in minor increases in tax collection. (JEL D22, H25, H26, O23)