Tax Evasion through Product Misclassification in the Presence of Multiple VAT Rates

Using firm-level, administrative tax information from Greece, this paper, presented in the ZEW Research Seminar, explores VAT evasion through a relatively understudied channel; product misclassification or mislabeling of standard- as reduced-rate VAT sales. The author exploit exogenous variation in the gains from product misclassification generated by increases in the VAT rate differential that applies to alcoholic and non-alcoholic sales between January 2010 to June 2011 to examine whether alcoholic sales-intensive subindustry firms such as night clubs and bars report an increased share of reduced-rate VAT remittances relative to restaurants and fast-food establishment. It is estimated that alcoholic sales-intensive subindustries are associated with 7.8%-7.9% more reduced-rate VAT remittances compared to the control subindustries during the policy reform period. Heterogeneity analysis produces no evidence that small firm size is associated with more product misclassification or that small sized nightclubs and bars remit relatively more VAT than restaurants and fast-food establishments. The study has important policy implications that provide descriptive evidence against the use of multiple VAT rate systems because they generate new, more difficult avenues for tax evasion from product misclassification. Unless e-billing is widely adopted, progress in the incorporation of information from third-party reporting alone cannot resolve tax evasion from product misclassification due to firm manipulation of the final consumption’s paper trail.