The Price Elasticity of Tax Evasion: Evidence from Ecuadorian Transaction Data

Context

What is the price elasticity of demand for international tax evasion services? Base erosion and profit shifting (both evasive and legal) for corporations as well as offshore tax evasion on part of individuals have been identified as important components of global trends in inequality (Guyton et al. (2020); Tørsløv, L. S. Wier, and Zucman (2018)) and relative decreases in tax collections (OECD (2015), Hines and Rice (1994)). Due to its clandestine nature, it is difficult to observe evasive tax strategy in a research setting. Moreover, a lack of shocks has limited researchers’ abilities to study quasi-experiments focusing on tax evasion.

Study Design

This study makes use of the novel data and legislative environment in Ecuador. As the global financial crisis emerged at the end of 2007, Ecuador, a completely Dollarized economy without conventional monetary policy tools, ratified the Impuesto a la Salida de Divisas (ISD), a tax on all foreign outflows. This tax operated as a quasi-monetary policy, aimed to limit the flight of US Dollars from the Ecuadorian economy. To facilitate the collection and enforcement of the ISD, the tax authorities, the Servico de Rentas Internas (SRI) installed comprehensive data infrastructure on the universe of transactions with foreign parties. This study combines this data with legislative shocks to the ISD that alter the tax’s rate and base (including changes in exemptions involving transactions with fiscal havens) to study the price-reactivity of sending funds to offshore bank accounts and foreign corporate affiliates.

Results and Policy Lessons

Jakob found that the outflows tax led to a sharp decrease in dividend payments to tax havens, suggesting a substantial scope for countries to act unilaterally in mitigating tax haven use and increasing tax collections.

He documents a 66% decrease in dividend payments sent to tax havens relative to non-havens following an increase in the cost of transacting with tax havens relative to non-havens by 5%. Exposed firms increased retained earnings in the short run by 60%. This response was largely unaccompanied by any change in post-tax investment behavior. Using administrative data on shareholder-company linkages to identify individuals highly connected to tax havens, he found that exposed individuals increased their domestic income reporting by 40% compared to the universe of unexposed taxpayers and paid 55% more in personal income taxes. This response was mainly driven by domestic capital and independent labor income flows and not through repatriation behavior.