Information frictions and learning dynamics: evidence from tax bunching in Ecuador

Abstract We examine how taxpayers learn to minimize personal income tax payments in the context of a rapidly formalizing economy with an expanding tax base. Initially, take‐up of possible generous tax deductions is low among taxpayers in Ecuador who start working in the formal sector. With increasing duration of employment, however, taxpayers become more likely to bunch at the tax exemption threshold using deductions. We exploit rich administrative data on the universe of taxpayers in Ecuador and an event study design to provide causal evidence on the learning mechanisms. We find that the spread of information is driven by the mobility of workers and tax preparers across firms.