Bunching at Zero by Portuguese Firms

Tax Administration Research Centre (TARC)

Further details

The question of whether individuals and firms manipulate their earnings to remain below thresholds in the tax schedule is of great relevance to estimating the extent of tax evasion in a given economy. This paper examines firms' behavior at zero profits, where a spike in the distribution of corporate income is pronounced. We model how tax-evading firms decide whether to mis-report their profits as zero or to drop out of the formal economy entirely to avoid paying any tax. Using a firm-level panel dataset from Portugal, we use bunching analysis to test the effects of an exogenous shock to enforcement that raised the costs of tax evasion for firms in certain sectors by giving incentives to consumers to ask for receipts for transactions conducted with such firms. We find that pre-reform, bunching at zero is more pronounced by firms in the targeted sectors but that the picture is reversed after the reform, suggesting that the policy was effective in increasing the costs of evasion for these firms and that this shock changed firm behavior as expected.