​Economics Seminar | Evading by Any Means? 

Enhancing taxation capability is a primary goal of policy makers around the world. The efforts to strengthen tax enforcement, however, is compromised when taxpayers shift evasion to non-targeted tax margins. This paper investigates firms’ substitution among different forms of illegal evasion induced by enforcement. Using the abolition of agriculture tax in China as an exogenous shock to VAT enforcement, we find large evasion shift effect that firms respond to tighter VAT enforcement by evading more payroll tax (social contributions): 1RMB increase in VAT payment leads to 0.147 RMB increase in payroll tax evasion. The effect is larger for firms with more financial constraints, lower profitability, more market competition, and higher labor intensity. These evidences suggest a mechanism of tax evasion due to loopholes in multi-dimensional state capacity: the enhancement of revenue collection by one branch may induce evasion on tax compliance on other dimensions that are endowed with weaker bureaucratic capability.