The optimal threshold for a value-added tax

One of the key features of a value-added tax-and often one of the most contentious-is the threshold level of turnover at which firms are obliged to register for the tax. Despite its importance, however, the question of the appropriate level at which to set this threshold has received little analytical attention. This paper first develops a simple rule characterizing the optimal threshold (when firms' sizes are fixed) in terms of a trade-off between tax revenues and collection costs. It then considers, in principle and by simulation, the implications for the optimal threshold of the production inefficiencies implied by the differential treatment of those above and below the threshold. (C) 2002 Elsevier B.V. All rights reserved.