How Illegal Trade Responds to Tariffs, When Importers Can Avoid: Evidence From Iran

While import taxes are easier to levy, there is increasingly more evidence that importers engage in trade tax evasion. The literature uses, trade gap, the difference between reports from the two ends of a trade link, as a proxy for illegal imports. Many papers have found a robust positive correlation between statutory import tax rates and trade gap. However, like any other tax, importers could avoid paying import duties through legal provisions. Such opportunities are abundant in Iran and could bias the evasion elasticity downward. Using disaggregated trade reports from 21 partners and Iran Customs Administration from 2004 to 2013, we show that a one-percentage-point increase in tax rate is significantly associated with a 1.8 percent increase in trade gap. But once we control for avoidance, this effect increases to 2.5 percent. In line with our expectation, there is also a significant negative correlation between our avoidance proxy and trade gap.