Response of tax credit claims to tax enforcement: Evidence from a quasi-experiment in Chile

Diesel in Chile receives different tax treatments depending on its use. If diesel is used in industrial activities, the diesel taxes paid can be fully used as a credit against VAT, but if it is used in freight or public transportation - basically trucks and buses - only a fraction of diesel taxes paid can be claimed as a tax credit for VAT payments. As a result of this different tax treatment, firms have incentives to use 'tax-exempted' diesel in activities requiring 'non-tax-exempted' diesel. This tax wedge therefore generates an opportunity for tax evasion, especially for firms with multiple economic activities, one of them being transport. In this paper, we analyse the impact of a tax enforcement programme implemented by the Chilean Internal Revenue Service (IRS), where letters requiring information about diesel purchases and use and vehicle ownership were sent to around 200 firms in 2003. Using different empirical strategies to consider the non-randomness of the selection of firms, the empirical results show consistently that firms receiving a letter decreased their diesel tax credits by around 10 per cent.