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

Most countries use VAT as their primary indirect tax and most have thresholds, usually based on turnover, below which businesses do not need to register. This creates a large and salient tax notch for small businesses whose turnover is around the threshold. This research project uses linked UK VAT and corporation tax returns between 2004 and 2009 from the HRMC Datalab. Approximately 44% of firms with turnover below the threshold are registered for VAT. Some firms restrict their turnover to stay just below the registration threshold. We develop a conceptual framework that allows simultaneously for these two features which generates predictions about how voluntary registration and bunching just below the threshold are related to intensity of input use, the share of B2C  transactions for a firm, opportunities for evasion via under-reporting of sales, and the competitiveness of the market in which the firm is located. Consistent with the theory, we find that voluntary registration is positively related to the intensity of input use and negatively to the share of B2C transactions, and the amount of bunching is related to these variables in the opposite way. There is some evidence that product market competition leads to more voluntary registration, and less bunching.

Li Liu and Ben Lockwood. CBT Working Paper 16/10