Overclaimed refunds, undeclared sales, and invoice mills: Nature and extent of noncompliance in a value-added tax

Value-added tax has seen phenomenal expansion in recent decades. Its appeal in part lies in its robustness to tax evasion relative to other tax instruments. Exploiting a tax reform from Pakistan that cuts the tax rate on five major industries of the country substantially, I estimate the size and nature of VAT evasion in the treated industries, finding that it ranges from 31–46% of the potential revenue. One important channel through which the evasion occurs is the overclaim of refunds, which constitute 11–23% of the potential revenue. Roughly two-fifths of the overclaimed refund is based on spurious invoices issued by invoice mills. Qualitatively, noncompliance is stronger in the latter stages of the supply chain, but it runs deep inside the chain, suggesting that on their own the self-enforcement mechanisms built into a VAT do not deter tax evasion fully.