VAT Notches, Voluntary Registration, and Bunching: Theory and UK Evidence

IMF Working Papers, September 27, 2019

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Canonical URL: VAT Notches, Voluntary Registration, and Bunching: Theory and UK Evidence

Using administrative tax records for UK businesses, the authors document both:
- bunching in annual turnover below the VAT registration threshold, and
- persistent voluntary registration by almost half of the firms below the threshold.
The empirical analysis uses linked VAT and corporation tax records from 2004-2014.
The authors find empirical support for the predictions of their conceptual framework.

The framework simultaneously explains the coexistence of:
- bunching just below the VAT registration threshold, and
- substantial voluntary registration by firms below the threshold.
The framework predicts that the following factors increase the likelihood of voluntary registration:
- higher intermediate input shares,
- lower product-market competition, and
- a lower share of business to consumer (B2C) sales.
The framework predicts the exact opposite impacts of these factors on bunching.

Data: linked VAT and corporation tax records covering 2004-2014.
Key empirical matches to theory:
- Evidence of bunching in annual turnover below the VAT registration threshold.
- Evidence that almost half of firms below the threshold are voluntarily registered.
- Empirical relationships consistent with model predictions regarding:
- intermediate input shares,
- product-market competition, and
- share of B2C sales.
The analysis documents persistent voluntary registration behavior alongside bunching, and attributes heterogeneity in firm responses to the predicted firm-level characteristics.

Heterogeneous firm responses to VAT registration notches imply that simple threshold-based policy changes may produce mixed behavioral outcomes:
- Policies that alter the registration threshold will interact with firm input structures, market competition, and B2C exposure to produce divergent effects on voluntary registration and bunching.
Diagnostic analysis of firm-level characteristics (intermediate input shares, measures of product-market competition, and B2C share) can help predict which firms are more likely to voluntarily register versus bunch below the threshold.
Revenue and compliance effects of VAT threshold reforms should account for:
- the coexistence of voluntary registration and bunching,
- the opposing predicted effects of firm characteristics on these behaviors.

VAT Notches, Voluntary Registration, and Bunching: Theory and UK Evidence