The Economic Impact of Audits

Study Context

While several studies have investigated the impact of tax audits on evasion among individuals in wealthy countries, we do not know much about the impact of audits on firms in developing countries. One might expect audits to function differently in developing countries for two reasons. First, the presence of a large informal sector in developing countries makes it hard to enforce the outcomes of an audit. Second, the limited availability of registries provides the authority with less information to cross-check.

In preliminary work, leveraging the authority’s rich administrative data, David found that taxpayers pay less taxes and are less likely to file taxes after an audit.

Next, he seeks to understand how an audit impacts a firm’s operation. The data in hand is rich in its scope and duration, but it is restricted to the formal sector. To understand what happens when firms do not file taxes, David, in close collaboration with the revenue authority, will develop a survey to conduct with both audited and unaudited firms before and after the audit.

Study Design

In preliminary work, to evaluate the impact of changes in the enforcement environment, David successfully used a triple-difference strategy. The work compared firms with high/low compliance risk, and high/low financial importance (a composite measure defined by the revenue authority) before/after the policy change in 2016.

To estimate the impact of being audited, he leverages variation in the audit selection process, part of which is data driven. Several of the administrative data sources have not been used by other researchers before. In addition, the survey would allow the authors to understand what happens to firms when they move to informality after an audit.

Results and Policy Lessons

Preliminary data shows that light touch enforcement interventions (desk audits) cause firms to self-correct their past tax returns, but the corrections do not lead to increased tax liabilities. More intense forms of tax enforcement interventions (issue/desk audits) lead to corrections filed by the revenue authority that should yield significant short-run revenue increases. However, they also lead to a drastic reduction in firms filing VAT taxes altogether. Specifically,  issue audits cause 14 percentage point drop in the probability of filing VAT taxes post-audit, and comprehensive audits cause a staggering 30 percentage point drop in VAT filing probability.

David and team are currently implementing the survey and additional results will come in soon.