QUASI-EXPERIMENTAL ANALYSIS ON THE EFFECTS OF ADOPTION OF A VALUE ADDED TAX

I. INTRODUCTION The value added tax (VAT) has displaced many different trade, sales, and manufacturing taxes in the past half century, becoming a major source of government revenue for an increasing number of countries. The tax has all the desirable non-distortionary theoretical properties of a sales tax, its incidence ultimately falling on consumers, but it is much harder to avoid, as the tax is collected at all intermediate steps during the production of a finished retail good rather than at the final sale. As a result, it has proven incredibly popular as it can collect a great deal of revenue (Keen and Lockwood 2010; Toder and Rosenberg 2010). While this tax is theoretically less distorting than other taxes for each dollar of revenue collected, there is limited analysis regarding its overall impact on the economy. Demonstrating that the tax also has few negative side effects would make it invaluable for developing countries looking for an effective tax instrument. Showing that a VAT is associated with increases in growth, trade, or investment would be solid evidence in favor of its adoption. However, empirical studies of VAT are rare. This study seeks to fill a hole in the literature, analyzing the overall economic impact of a VAT, which will allow policy makers to make informed decisions of the costs and benefits of this tax. Understanding the effects of the VAT is vital, as the importance of the VAT is unlikely to decline in the future. The IMF increasingly suggests that countries raise more revenue through adopting a VAT or raising VAT rates (Bird 2010). Many countries, facing rising pressures on pension programs as a result of changing demographics, are funding social programs from general revenues rather than payroll taxes, which usually means shifting the overall tax composition of government revenues toward VATs (Bird and Smart 2012). A VAT is a requirement for EU membership, and other international organizations are considering their own mandatory VATs, with a unified set of rules and repayment systems at an international rather than national level, such as the Gulf Cooperation Countries (Cnossen 1998; Kapur 2012). As more countries adopt VATs, international payment mechanisms for collecting VATs will become more efficient (Ebrill et al. 2001) and VATs will become more popular in the future. As a country chooses when to enact a VAT, simply estimating the effect of adoption on macroeconomic variables, such as trade or growth, through normal regression techniques, will result in biased estimates, as countries that choose to adopt a VAT may be fundamentally different from those who do not. In order to solve this selection problem, I use survival analysis to generate probabilities of VAT adoption to be used as propensity score for 192 countries from 1967 to 2012. I then employ matching methods to obtain the causal effects of VAT adoption among 112 countries, 90 of which do eventually adopt, from 1986 to 2007 in the year of adoption and for 5 years after. (1) The results of this study reveal that VAT adoption is associated with increases in investment, and less robustly increases in growth as well as decreases in inflation and government spending. There is no evidence of changes in trade once controlling for selection. (2) This study is organized as follows. Section II covers background on previous studies on the VAT and other tax policies. Section III describes the adoption equation using survival analysis, both its determinants and results. Section IV introduces the matching process. Section V describes the results of the matching as well as some robustness checks. Section VI concludes. II. BACKGROUND Starting with France in 1954, and reaching its first developing country in 1960 when it was enacted by the Cote d'Ivoire, 166 countries have at some point implemented a VAT as of January 2013, and once passed, nearly all countries retain it. Figure 1 shows aggregate VAT adoption over time and Figure 2 shows the adoptions in each year. …