Tejaswi Velayudhan (UCI)

Title: Limits to VAT Self-Enforcement: Role of Network Frictions in Compliance

How do production networks affect enforcement and compliance in a Value-Added Tax (VAT)? The theoretical result that enforcement action in a VAT also raises compliance upstream along the production chain relies on frictionless network formation. Using a field experiment with Indian VAT-registered firms, this paper shows that with widespread late payment and network frictions, these positive spillovers disappear and the direct impact of enforcement on on-time payment is dampened. Nudges to make on-time payments failed to change the behavior of delinquent taxpayers whose suppliers were also delinquent, and they continued to trade with these delinquent suppliers. These results illustrate the unequal burden of VAT self-enforcement on firms depending on their production structure. For the tax authority, they demonstrate the limits of relying on self-enforcement to ensure VAT compliance. Counter to the prevailing wisdom that the tax authorities' efforts should be directed at the retail stage where VAT incentives are weakest, our results suggest a reason to target enforcement at key upstream firms.