Informality, Consumption Taxes and Redistribution

Gadenne, Lucie; Jensen, Anders; Bachas, Pierre

Informality, Consumption Taxes and Redistribution

Lucie Gadenne, Anders Jensen and Pierre Bachas

No 14945, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Can consumption taxes reduce inequality in developing countries? We combine household expenditure data from 31 countries with theory to shed new light on the redistributive potential and optimal design of consumption taxes. We use the type of store in which purchases occur to proxy for informal (untaxed) consumption. This enables us to characterize the informality Engel curve: we find 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. We extend the standard optimal commodity tax model to allow for informal consumption and calibrate it to the data to study the effects of different tax policies on inequality. Contrary to consensus, we show that consumption taxes are redistributive, lowering inequality by as much as personal income taxes. Once informality is taken 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: Household budget surveys; Inequality; Informality; Redistribution; Taxes (search for similar items in EconPapers)
JEL-codes: E26 H21 H23 O23 (search for similar items in EconPapers)
Date: 2020-06
New Economics Papers: this item is included in nep-iue, nep-mac and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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