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Informality, Consumption Taxes and Redistribution

Author

Listed:
  • Gadenne, Lucie
  • Jensen, Anders
  • Bachas, Pierre
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.

Suggested Citation

  • Gadenne, Lucie & Jensen, Anders & Bachas, Pierre, 2020. "Informality, Consumption Taxes and Redistribution," CEPR Discussion Papers 14945, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:14945
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    6. Younes Zouhar & Jon Jellema & Nora Lustig & Mohamed Trabelsi, 2021. "Public Expenditure and Inclusive Growth - A Survey," Commitment to Equity (CEQ) Working Paper Series 109, Tulane University, Department of Economics.
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    14. Alain Babatounde & Bart Capeau & Romain Houssa, 2023. "Welfare effects of indirect tax policies in West Africa," DeFiPP Working Papers 2301, University of Namur, Development Finance and Public Policies.
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    16. Zhila Abshari & Glenn P. Jenkins & Chun-Yan Kuo & Mostafa Shahee, 2021. "Progressive Taxation versus Progressive Targeted Transfers in the Design of a Sustainable Value Added Tax System," Sustainability, MDPI, vol. 13(20), pages 1-17, October.
    17. Zarate Vasquez,Roman David, 2022. "Spatial Misallocation,Informality, and Transit Improvements : Evidence from Mexico City," Policy Research Working Paper Series 9990, The World Bank.
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    20. Das, S & Gadenne, L & Nandi, T & Warwick, R, 2022. "Does going cashless make you tax-rich? Evidence from India’s demonetization experiment," CAGE Online Working Paper Series 605, Competitive Advantage in the Global Economy (CAGE).
    21. da Costa, Carlos E. & Santos, Marcelo R., 2023. "Progressive consumption taxes," Journal of Public Economics, Elsevier, vol. 220(C).
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    More about this item

    Keywords

    Household budget surveys; Inequality; Informality; Redistribution; Taxes;
    All these keywords.

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development

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