The inequality impact of consumption taxes: An international comparison

Abstract

Consumption taxes are often considered as the most regressive component of the tax system. However, there are only few estimates, and even fewer international comparisons, of the redistributive impact of consumption taxes in the literature, due to scarce data on household expenditures. We use household budget and income surveys and microsimulation to provide consistent estimates of the regressivity of consumption taxes for a large panel of countries and years. We propose a new method for imputing household consumption expenditure across countries: this can be applied to any dataset that contains income information and potentially other socio-demographic variables. We stress that using housing rents, when available, to impute household consumption and calculate consumption taxes significantly improves the accuracy of the model. We have three results. First, in almost all countries, consumption taxes fall disproportionately on low-income households: the top income decile pays a share of its income in consumption taxes that is only 60 percent of what the bottom half pays. Second, income inequality is higher when calculated after consumption taxes, and this rise in inequality offsets one-third of the redistributive effect of tax-benefit systems. Last, cross-country differences in the inequality effect of consumption taxes are mainly explained by different implicit tax rates (from 7 to 30 percent in our sample), rather than variations in the distribution of household consumption patterns. Consumption taxes should therefore be taken into account when comparing income inequality and tax-benefit systems across countries, as the most-redistributive systems generally come with high consumption taxes.