The Double Dividend of a Joint Tariff and VAT Reform

This paper provides empirical evidence on a novel complementarity between VAT and trade taxes. Downstream domestic firms require VAT receipts from importers to claim VAT on purchases, increasing incentives for honest reporting of imports. Trade gap, the difference between mirror and domestic trade reports in Iran at 6-digit HS disaggregation, is used to measure this complementarity. Iran introduced VAT in 2008 and, since then, has increased its rate from 3 to 9 percent. Difference-in-differences estimates show that a 1 percentage point increase in the VAT rate reduces the trade gap by about 2 percent. Consistent with the compliance mechanisms for VAT, a smaller effect for consumer products that have a shorter value chain is observed. Findings suggest that replacing tariffs with VAT results in a double dividend. Tax revenue might increase due to better tariff compliance and a broader VAT base