Reassessing the regressivity of the VAT

Abstract

AbstractThis paper reassesses the often‐made conclusion that the value‐added tax (VAT) is regressive, drawing on tax microsimulation models constructed for an unprecedented 27 OECD countries. The paper first considers the competing methodological approaches used in previous distributional studies, highlighting the impact of savings patterns on cross‐sectional analysis when VAT burdens are measured relative to income. It is argued that measuring VAT burdens relative to expenditure – thereby removing the influence of savings – can be expected to provide a more reliable picture of the distributional impact of the VAT. On this basis, the VAT is found to be either roughly proportional or slightly progressive in most of the 27 OECD countries examined. Nevertheless, the results for a small number of countries highlight that broad‐based VAT systems that have few reduced VAT rates or exemptions can produce a small degree of regressivity. Results also show that even a roughly proportional VAT can still have significant equity implications for the poor – potentially pushing some households into poverty. This emphasises the importance of ensuring the progressivity of the tax‐benefit system as a whole in order to compensate poor households for the loss in purchasing power from paying VAT.