Key message 2 – VAT administration faces a last-mile problem.
The self-enforcing properties of VAT systems for B2B transactions rest on the incentives that they create for buyers to ask sellers for receipts in order to claim tax credits. Final consumers do not have similar incentives to ask for receipts. The lack of paper trail allows firms to more-easily under-report sales, potentially reducing revenue mobilisation at the retail stage, as documented by Pomeranz (2015) in the Chilean context.
This ‘last-mile problem’ of VAT systems is an important flaw because, in principle, the noncompliance could also be transmitted upstream in the supply chain through collusive evasion: retailers under-reporting their sales may be especially willing to under-report their inputs to remain under the radar of the tax authority, which in turn allows their suppliers to under-report their own sales, etc. The sheer number of small taxpayers also complicates enforcement at the retail stage.
A first step towards better monitoring retail sales is to improve the technology used to issue receipts to final consumers. For instance, requiring retailers to issue standardised receipts (e.g., with time stamps and serial numbers) increases the costs of concealing their sales. More recently, electronic billing machines (EBMs), which retailers are now required to use in a number of countries, have made the tampering of receipts more difficult and increased the amount of information the tax authority has available over final sales. Eissa et al. (2014) show that the recent roll-out of EBMs improved compliance in Rwanda.
However, EBMs are only useful if receipts are issued to final consumers. Ensuring that receipts are issued is costly for consumers in terms of both time and effort. EBMs are thus unlikely to resolve the last-mile problem by themselves. For instance, Eissa et al. (2014) find that receipts were only issued in 21% of a sample of retail transactions. Moreover, in a recent survey in the same country, 33% of consumers were worried that retailers would increase prices if they asked for receipts (Campbell et al., 2017).
Consumers as tax auditors in Brazil
A case that has been studied in detail is the policy implemented in the state of São Paulo, Brazil, in 2007 (Naritomi, 2016). Consumers have the option of providing their taxpayer identification number (ID) to retailers for it to be recorded on receipts, and retailers are required to submit the information for all their receipts, including consumers’ ID numbers, to the tax authority. Consumers then earn lottery tickets and tax rebates based on the total value of the receipts featuring their ID number and can set up an online account to collect their rewards. The online account also opens a direct communication channel with the tax authority for consumers to blow the whistle on noncompliant retailers.
Naritomi (2016) shows that consumers responded strongly to the incentives: more than 15 million consumers actively participated and consumers increased their participation following lottery wins. This new consumer monitoring resulted in an improvement in compliance: the policy increased reported revenue by retail firms by more than 20% over four years. This is despite opportunities for collusive evasion between consumers and retailers, as the rewards for consumers remained smaller than the tax burden for retailers. In addition, firms increased their reported revenue after being reported as non-compliant, showing that the diffused monitoring tool enables the whistleblower channel to generate a credible threat.
To address this problem, tax authorities around the world have been looking for ways to incentivise consumers to ask for receipts from as early as in the 1960s, although such incentives have been adopted more widely only recently. Incentive bundles vary across countries and typically include a combination of lotteries and tax rebates based on consumers’ receipts, as well as appeals to civic duty or ‘tax morale’ (Campbell and Naritomi, in progress). See the box on page 4 for an example of an effective incentive policy implemented in Brazil.
IMPLEMENTING COMPLIANCE INCENTIVES
Consumer incentives are quite costly to implement, as they equally reward transactions that would be reported in the absence of any incentives and transactions that would otherwise be evaded. Thus, consumer participation (i.e., programme take-up) and its impact on tax evasion must be high for such incentives to generate new revenue.
The experience in other countries is in fact mixed, arguably due to policy design problems and high participation costs for consumers. This suggests that careful attention must be devoted to their design and to the local environment for such schemes to effectively address the last-mile problem of VAT systems.