VAT Notches

We develop a conceptual framework which captures the effect of the VAT system on profit by two effective taxes. This allows (i) predictions of the determinants of voluntary registration and bunching at the registration threshold; (ii) develops a formula for estimating the elasticity of value-added with respect to the statutory tax. We show that the marginal excess burden of the tax on suppliers is measured by this elasticity, extending Feldstein.s analysis of the elasticity of taxable income to an indirect tax setting. We bring the theory to the data, using linked administrative VAT and corporation tax records in the UK from 2004-2009. Consistently with the theory, voluntary registration is positively related to the intensity of input use and negatively related to the share of B2C transactions. There is bunching at the VAT threshold, and the amount of bunching is negatively related to the intensity of input use and positively related to the share of B2C transactions, again consistently with the theory. We provide an estimate of the elasticity of the VAT tax base in the range of 0.09 and 0.18.