Closing the Gap: How Tax Administration Performance Shapes Compliance

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This paper examines the impact of tax administration performance on tax compliance gaps across countries. Building on the Allingham and Sandmo framework, we consider institutional effectiveness and the social acceptability of the tax system as key determinants of taxpayer behavior. We use a novel panel dataset of VAT gap estimates, results of standardized tax administration diagnostic assessments (TADAT), and tax administration institutional and operational data (ISORA). We test the model empirically by combining the Hausman-Taylor and Mundlak-Krishnakumar frameworks. Our findings reveal a robust negative relationship between tax administration effectiveness-based on TADAT scores-and VAT compliance gaps. We find that an increase in a tax administration's TADAT score from 1.85 to 2.32 (approximately D+ to C+) is associated with an 0.6 percentage point increase in VAT revenue as a share of GDP, reflecting reduced VAT noncompliance. Including spillover effects on Corporate Income Tax (CIT) compliance, the total revenue gain could reach 1.3 percent of GDP. We also find that higher social acceptability of the tax system is linked to lower noncompliance. These results underscore the critical role of strengthening institutions to improve tax compliance and enhance tax revenue.

Subject: Revenue administration, Revenue performance assessment, Tax administration core functions, Tax Administration Diagnostic and Assessment Tool (TADAT), Tax gap, Taxes, Value-added tax

Keywords: Tax administration core functions, Tax Administration Diagnostic and Assessment Tool (TADAT), Tax Administration Effectiveness, Tax Compliance, Tax Evasion, Tax gap, Value-added tax