Why digital transactions aren’t a silver bullet for tax compliance: Evidence from Uruguay

Anne Brockmeyer and Magaly Sáenz Somarriba in this interesting research from Uruguay show digital transactions are not a panacea for tax compliance:

Electronic payment technologies have long been hailed as a way to formalise transactions, increase tax compliance, and strengthen state capacity. This column examines the effect of financial incentives on the take-up of such technologies among firms and consumers in Uruguay, and on the tax compliance of firms. In response to a VAT rebate for paying with a debit or credit card, consumers increased their use of such cards, but firms’ use of point-of-sales terminals did not increase and tax compliance was not affected.

Why firms did not increase POS?

The number of firms with at least one point-of-sale (POS) terminal did not increase when the rebates were introduced. Only firms that already had a POS prior to the reform increased POS usage, by using a larger number of POS terminals.

These results are consistent with the fact that using a POS is costly for firms that are not yet fully tax compliant. Previously unreported cash transactions can be revealed through the POS’s digital paper trail. Indeed, in monthly event studies, we find that VAT liabilities increase sharply when firms use a POS terminal for the first time.

We also show that small subsidies for POS usage and reductions in card fees did little to incentivise POS adoption. The results imply that much larger financial incentives, or a mandate may be needed to spur extensive margin POS adoption.