We examine how firms’ input choices respond to the value-added tax (VAT) on purchases, using detailed
VAT return data from Pakistan and a quasi-experimental variation in electricity VAT rates. Contrary to traditional
theories that intermediate VATs don’t affect production decisions, our study reveals a significant elasticity of
electricity demand to VAT rates (-0.81). These findings aren’t attributed to tax evasion shifts but to frictions in the
VAT refund system. Specifically, many firms, not collecting VAT on output, depend on government reimbursements
for their VAT credits, explaining our results.
Virtually all electricity produced and sold in developing countries is through bilaterally negotiated long-term contracts between independent power producers (IPPs) and state-owned utilities. These power purchase agreements (PPAs) set the cost of electricity in a country, an important factor of production. Yet information on the terms behind PPAs is rarely disclosed, making them potentially ripe for rent extraction. In a first-of-its-kind effort, we compile a novel dataset on the universe PPAs signed in Pakistan since private participation began in 1994. Four features characterise PPAs in Pakistan: (i) they were negotiated and signed bilaterally, without competitive procurement; (ii) a long contract tenor, typically 25-40 years; (iii) a “cost-plus” nature, which guarantees real returns on equity, often exceeding 20%, with full cost pass through; and (iv) a “take-or-pay” clause, meaning payments flow to generators irrespective of how much electricity they produce. These “capacity payments” exceed Pakistan's combined annual budget for health, education, and social protection. Digging deeper, we use confidential financial disclosures on actual revenues and costs for a subset of IPPs to show that firms artificially inflate their true fuel costs in PPAs to generate excess profits. As a result, some producers earn annual real returns on equity above 80%, far beyond what is contracted. On average, actual profits are 83% higher than what is contracted. In ongoing work, we are collecting information on the ownership of IPPs to establish whether politically connected firms are able to engage in rent extraction by inflating costs. To conclude, we use a general equilibrium model to size the economic costs of these lopsided contracts by comparing against counterfactual electricity prices in the absence of rent extraction and in the presence of competitive procurement.
The ability of governments to expand energy access runs aground when state capacity is limited. Weak enforcement creates a leaky bucket as electricity theft and unpaid bills go unchecked. As a result, energy access gets curtailed, especially for the poor. Together with the government of Pakistan, we are evaluating a novel intervention that seeks to shift social norms on the payment of electricity in areas beyond the reach of the state. Influential agents, notably local religious institutions (mosques), will deliver messages against electricity theft in treatment communities. A separate treatment arm provides financial incentives to pay for electricity. We use our experimental estimates to derive demand curves for electricity and theft using a simple theoretical model to quantify the fiscal value of the enforcement intervention. Our study takes place in Khyber Pakhtunkhwa, a rural, poor, and highly religious area of Pakistan where theft is widespread, making it an ideal setting to test if this is a cost-effective solution. Our proposal builds on a long-term engagement with the highest levels of the federal government in Pakistan.
How costly are financial frictions in the presence of variable markups? We analyze the interaction between financial frictions and variable markups and draw implications for the ability of financial frictions to explain income per capita differences across countries. For this purpose, we build a quantitative heterogeneous-agent model of producer dynamics. Intermediate producers are born with heterogeneous permanent productivity and are also subject to transitory productivity shocks. They engage in monopolistic competition. Their outputs are aggregated into a final good such that the demand elasticity faced by intermediate producers is decreasing in their relative output, making markups increasing in relative output. In order to hire capital, an intermediate producer must take an intra-period loan from financial intermediaries, but imperfect contractual enforcement limits the loan size to a multiple of the producer's collateralizable assets. Intermediate producers are born with no collateral, but they accumulate it over time using their profits. We calibrate the model using data from Pakistan. First, we match salient features of the firms' lifecycle and the distribution of sales across firms. Second, after estimating firm-level markups, we match the aggregate markup and the empirical relationship between market shares and markups. We find that financial frictions are more costly in the presence of variable markups: a reduction in financial frictions increases output per capita more when markups are variable relative to when markups are constant. This additional benefit of reducing financial frictions stems from (1) productive producers with little accumulated collateral overcoming their collateral constraints faster by charging higher markups and thus (2) relatively high markups being restricted by the heightened competition.