VAT notches, voluntary registration and bunching: theory and UK evidence

Most countries around the world use VAT as their primary indirect tax. It is standard to set a minimum registration threshold, usually based on annual turnover, below which businesses do not need to register for VAT. In the EU, a large majority of countries currently have a registration threshold, with the UK threshold being the highest. As VAT rates are often quite high, this may create a large and salient tax “notch” for businesses whose turnover is around the threshold – that is there could be a significant jump in tax liabilities from going form just below, to just above, the threshold.  

Using confidential administrative tax records for UK businesses in the HMRC Datalab, the paper documents both (a) bunching in annual turnover just below the VAT registration threshold - that is a large number of firms have annual revenue just below the threshold; and (b) persistent voluntary registration by almost half of the firms below the threshold. At first sight, there two effects seem contradictory, in that the firms that bunch below the threshold are likely to be aiming to keep their revenue down so as not to have to register, while many of those below the threshold register voluntarily. 

The paper develops a conceptual framework that simultaneously explains these two apparently conflicting facts. The framework predicts that higher intermediate input shares, lower product-market competition and a lower share of business to consumer (B2C) sales would lead to voluntary registration. The predictions are the opposite for bunching. The paper tests the theory using linked VAT and corporation tax records from 2004-2014, and find empirical support for these predictions.


Li Liu, Ben Lockwood, Miguel Almunia, Eddy HF Tam ’VAT Notches, Voluntary Registration, and Bunching: Theory and UK Evidence‘, Review of Economics and Statistics, forthcoming.