Publication: Informality, Consumption Taxes and Redistribution
Date
2020-06
ISSN
Published
2020-06
Author(s)
Bachas, Pierre
Gadenne, Lucie
Jensen, Anders
Abstract
Can consumption taxes reduce inequality
in developing countries? This paper combines household
expenditure data from 31 countries with theory to shed new
light on the redistributive potential and optimal design of
consumption taxes. It uses the place of purchase of each
expenditure to proxy for informal (untaxed) consumption
which enables characterizing the informality Engel curve.
The analysis finds that the budget share spent in the
informal sector steeply declines with income, in all
countries. The informal sector thus makes consumption taxes
progressive: households in the richest quintile face an
effective tax rate that is twice that of the poorest
quintile. The paper extends the standard optimal commodity
tax model to allow for informal consumption and calibrates
it to the data to study the effects of different tax
policies on inequality. Contrary to consensus, the findings
show that consumption taxes are redistributive, lowering
inequality by as much as personal income taxes. These
effects are primarily driven by the shape of the informality
Engel curve. Taking informality into account, commonly used
redistributive policies, such as reduced tax rates on
necessities, have a limited impact on inequality. In
particular, subsidizing food cannot be justified on equity
or efficiency grounds in several poor countries.
Citation
“Bachas, Pierre; Gadenne, Lucie; Jensen, Anders. 2020. Informality, Consumption Taxes and Redistribution. Policy Research Working Paper;No. 9267. © World Bank, Washington, DC. http://hdl.handle.net/10986/33851 License: CC BY 3.0 IGO.”
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