۱- Introduction

۲- A novel approach to detecting tax evasion

۳- Application: policy shock in Turkey

۴- “Missing trade” approach as external validation

۵- How persistent is evasion?

۶- Conclusions

References

Abstract

This paper draws attention to import duty evasion as a margin through which firms adjust to changes in trade policy. This margin is different from the other forms of adjustment, as it can be employed very fast and thus it may constitute the initial reaction to the shock before a slower adjustment through the other channels takes place. The study also proposes a new method of detecting tax evasion in international trade, based on deviations from Benford’s law. It applies the method in the context of an unexpected policy change in Turkey that increased the cost of import financing. The results are consistent with an immediate increase in tax evasion in the affected import flows, which dies down a year later. A standard approach to detecting tariff evasion, based on “missing trade”, confirms these conclusions.

Introduction

One of the key questions in international trade is how firms adjust to changes in trade policy. The literature has demonstrated theoretically and empirically that the adjustment can take place through firm entry and exit, reallocation of market shares driven by differences in firm productivities and changes to the product portfolio. This paper draws attention to another margin of adjustment—evasion of import duties in response to increases in border taxes. This margin is different from the other forms of adjustment, as it can be employed very fast and thus it may constitute the initial reaction to the shock before a slower adjustment through the other channels takes place. Understanding and acknowledging the existence of this margin matters, as any analysis of the consequences of short-run trade policy changes that fails to take into account changes in evasion is likely to present a distorted picture of reality. By its very nature tax evasion is difficult to detect as the parties involved have every incentive to conceal their lack of compliance with the tax law. Despite the great importance of tax evasion to public policy choices, it remains elusive and difficult to detect through a statistical analysis. This paper contributes to the literature by proposing a new method of detecting tax evasion in the context of border taxes. The proposed method is based on Benford’s law, which describes the distribution of first digits in economic or accounting data.