Informality, Consumption Taxes and Redistribution

Bachas, Pierre Jean; Gadenne, Lucie; Jensen, Anders

Informality, Consumption Taxes and Redistribution

Pierre Jean Bachas, Lucie Gadenne and Anders Jensen

No 9267, Policy Research Working Paper Series from The World Bank

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.

Keywords: Labor Markets; Tax Administration; Tax Law; Economic Adjustment and Lending; Macro-Fiscal Policy; Taxation&Subsidies; Public Finance Decentralization and Poverty Reduction; Public Sector Economics; Tax Policy; Rural Labor Markets; Gender and Development (search for similar items in EconPapers)
Date: 2020-06-01
New Economics Papers: this item is included in nep-iue, nep-pbe and nep-pub
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Citations: View citations in EconPapers (14)

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