Vat in Emerging Economies : Does Third Party Verification Matter?

A key stated advantage of the value-added tax (VAT) is that it allows the tax authority to verify transactions by comparing seller and buyer transaction reports. However, there is limited evidence on how these paper trails actually affect VAT collections particularly in low compliance environments. We use a unique data set (the universe of VAT returns for the Indian state of Delhi over five years) and the timing of a policy that improved the tax authority's information about buyer-seller interactions to shed light on this issue. Using a difference-in-difference strategy we find that the policy had a large and significant effect on tax collections from wholesale firms relative to retail firms. We also find significant heterogeneity with almost the entire increase being driven by changes in the behavior of the biggest taxpaying firms. We also find suggestive evidence that improvement in information and enforcement are complementary for a subset of firms