Tax Design-Tax Evasion Relationship in Serbia: New Empirical Approach to Standard Theoretical Model Sasa Randjelovic Jelena Zarkovic-Rakic University of Belgrade – Faculty of Economics 2013 EUROMOD research workshop Technical University of Lisbon, Lisbon - Portugal 2-3 October 2013

Outline Tax evasion: theoretical framework Tax evasion: literature review and aim of the paper Tax reform scenarios Data and methodology Research design Results Concluding remarks

Income tax evasion: theoretical framework Allingham-Sandmo model of determinants of tax evasion:  True income (+, -, 0)  Penalty rate (-)  Probability of detection (-)  Marginal tax rate (-): Yitzhaki’s critics:  if fine is a function of evaded tax a rise in the tax rate triggers decline in tax evasion

Income tax evasion: literature review and aim of the paper Empirical literature:  Positive impact of increase in probability of detection and fines (Pommernehe (1996), Keen (2008))  Tax evasion rises as true income is rising (Alm (1992))  Negative relationship between MTR and non-reported income (Alm (1992), Pommernehe (1996))…confirms A-S model Tax evasion decision – a question of rational choice under uncertainty  …then taxpayer would make tax evasion decision based on the change in disposable income, instead based on change in after-tax income Aim of the paper:  Investigate the tax evasion response to change in EMTR, due to tax reform Based on Serbian data

Tax reform scenarios Flat Tax - Scenario 1 Comprehensive IT - Scenario 3 Dual IT - Scenario 3 Taxable income Sum of income from all sourcesLabor incomeCapital income Tax baseGross income decreased by deductionsCapital income Personal allowance RSD 9,000 (20% of AW) / Dep. children allowance RSD 4,000 (9% of AW) / Health care expenditures /Full amount / Educational expenditures /Up to RSD 4,000 / Tax Rate(s)15%10%, 20% and 25% 10%, 15% and 20% 10%

Data and methodology SRMOD – tax & benefit microsimulation model for Serbia Econometric analysis of cross-section data: OLS method Dataset used in SRMOD:  Living Standard Measurement Survey 2007 Survey performed by the Statistical Office of Serbia Sample: 5,557 households (17,375 individuals)

Research design Research consists of three steps:  Computation of the EMTR in SRMOD (for baseline and reform scenarios); EMTR (Effective Marginal Tax Rate)  Econometric estimate of elasticity of non-reported income to the EMTR, using micro data;  Computation of changes to the amount of non-reported income By using the results on the changes to the EMTRs (under each reform scenario) and the estimated elasticity of non-reported income to the EMTR

Results: Income Tax Evasion in Serbia – scale and structure Tax evasion rate: (non-reported income/reported income)x100 Tax evasion rate per deciles Type of income % of labor income Non- declaration rate Tax evasion rate % of taxpayers Employment75%9,8%8,9%16,6% Self-employment25%78,3%43,9%64,4% Total100%26,9%21,2%25,6%

Results: modeling tax evasion Elasticity of tax evasion rate (TAR) to emplyoment income (EMPY), self- employment income (SEMPY) and EMTR The results confirm Yitzhaki teorem Dependent variableIndependent variable logTARlogEMPYlogSEMPYlogEMTR Coefficient-0,63***0,48***-0,30*** t-ratio-9,304,67-1,85 p-values0,000 0,068 Statisical properties R 2 =0,82; F (3, 79) =251,15 (p=0,000); JB=1,80

Results: modeling tax evasion Ceteris paribus, each reform scenario would yield slight increase in tax evasion: comprehensive>flat>dual  The effects could be reduced by increase in probability of detection Flat PITDual PIT Comprehensive PIT ΔEMTR, in percent-18.8%-15.6%-20.1% Tax evasion-EMTR elasticity-0.30 Δ tax evasion, in percent5.6%4.7%6.0% Tax evasion rate after the reform22.4%22.2%22.5%

Concluding remarks Each reform scenario would imply fall in EMTR  ranging from 4.7 to 5.6 pp Propensity to non-declaration rises as true income is increasing There is statistically significant difference in respect of evasion of tax on employment and self-employment  Collection method does matter When fine is a function of tax evaded, tax evasion is positively related to EMTR  …in accordance with Yitzhaki theorem Further steps:  Modeling for different probabilities of detection and fines?  Multi-country verification of Yitzhaki theorem?

Thank you for the attention! Questions or comments?