Using Computerized Information to Enforce VAT: Evidence from Pakistan

I test the claim that VAT’s in-built third-party information trail, together with electronic filing, deters tax evasion automatically. Using a reform which utilizes information beyond VAT trail and authorizes a computerized risk analysis system to accept or reject tax credits in real time, my difference-in-differences estimates show that claims declined by fifty percent. Based on firm heterogeneity, the response ranges from thirty to ninety percent. Ten percent of treated firms were fake, created for missing trader fraud. Lower bound estimate of increase in net VAT collection at country level is ten percent. I find that traditional VAT enforcement mechanisms of cross matching, audit and recovery fail to deter evasion in developing countries but a risk based real time enforcement system is effective. Because this system eliminates the need for reverse charge, its tax policy implications extend to developed countries.