Harnessing Deductions to Increase Tax Compliance and Formalization

We evaluate a tax reform in Ecuador that introduced generous deductions from personal income taxes (PIT), encouraging consumers to request receipts. The reform addresses tax evasion by targeting small self-employed businesses that mainly sell goods or services not subject to value-added taxes (VAT) but that often evade income taxes. Exploiting plausibly exogenous variation in receipt demand due to the distribution of taxpayers across regions and professions, we find significant increases in reported profits among self-employed businesses exposed to the reform. We document spillover effects on VAT. Our net-revenue impact analysis suggests the additional tax payments outweigh the foregone tax revenue. (JEL H24, H25, H26, J23, K34, O17)