The heterogeneous effects of labor informality on VAT revenues: Evidence on a developed country

Abstract

The value-added tax is spread in many countries primarily because it allows rising public revenues, but its revenue performance can be undermined in the presence of informality. We document the existence of heterogeneous effects of labor informality on VAT collection in a developed country such as Italy. By using novel regional administrative data on VAT revenues, we find that labor informality produces negative effects on total VAT collection, including VAT on production and consumption, and positive effects on VAT revenues from consumption only. We also find that the consequences of labor informality on VAT collection depend on the size of informality, by approximating an-inverted U-relation. As for Italy, we explain such heterogeneous effects with the presence of regional differences in labor market conditions. We also document that labor informality has heterogeneous effects on VAT collection when considering specific productive sectors, and the cyclical consequences of the Great Recession.