The State Capacity Ceiling on Tax Rates: Evidence from Randomized Tax Abatements in the DRC

Abstract

How can developing countries increase the tax revenue they collect? In collaboration with the Provincial Government of Kasaï-Central, we evaluate an experiment in the D.R. Congo that randomly assigned 38,028 property owners to different property tax liabilities. We find that status quo tax rates are above the revenuemaximizing (Laffer) tax rate. Reducing the tax rate by approximately 34% would maximize government revenue by increasing tax compliance. We then investigate how responses to tax rates interact with enforcement. We exploit two sources of variation in enforcement – randomized enforcement letters and random assignment of tax collectors – and show that the Laffer rate increases with enforcement. Replacing tax collectors in the bottom 25th percentile of enforcement capacity by average collectors would raise the Laffer rate by 42%. Tax rates and enforcement are thus complementary levers. According to our estimates, a government that adjusts tax rates and increases enforcement independently would increase revenue by 61%, while a government that takes their complementarity into account and adjusts both optimally would instead raise revenue by 77%. These findings provide experimental evidence that low government enforcement capacity sets a binding ceiling on the Laffer tax rate in some developing countries, thereby demonstrating the value of increasing tax enforcement in tandem with tax rates to expand fiscal capacity.