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distributional impact of VAT: how regressive? (1)

Apart from resource allocation issues, one of the most interest to when assessing fiscal policy is the distributional dimension. Both the expenditures made by the public and the resources it gets through taxes affect the level of life of individuals in an economy. For such an impact analysis necessary, be taken into account all the constituent elements of the budget. However, given the numerous challenges that this is common for incidence analysis proposed more modest goals, making assessments "partial" incidence (both differential and absolute).

In this sequence of posts will try to make an assessment exercise absolute incidence of VAT from a purely theoretical and deliberately simplified, comparing the two main approaches in the literature (incidence and impact on the annual life cycle) under a range of different specifications of consumption patterns, ranging from a macro function "ad-hoc Keynesian" to more sophisticated theoretical models as the hypothesis of consumption smoothing and liquidity constraints . (In a future post, the idea will add more realistic extensions on the same subject, exemptions, grants, inflation, etc.. The purpose of the exercise, if such a thing exists, is to identify the determinants of the regressivity of VAT.)

distributive impact and approaches

The determination of the approach is not trivial, as the incidence results depend largely on the definition of welfare proxies (eg income / consumption current / permanent, etc.). and tax burdens employed. In this regard, Metcalf (1992) makes a brief but interesting description of the arguments made in the '80s about the distributional effects of introducing a value added tax in the United States, a country that taxes consumption by taxing sales ( sales tax). By then, the practice common to assess the progressivity or regressivity of a tax meant to calculate what proportion of income goes to pay this tax, all in annual terms. Thus, if we assume without loss of generality that the income of the period t is exclusively for consumption and savings (equation 1), we conclude that the tax burden associated with a consumption tax aliquot k is determined by Equation 2:

From Equation 2 it is obvious why the VAT is a regressive timely perspective : VAT taxes consumption and is almost a stylized fact that it has greater share of income of individuals in lower income levels (which are those with less ability to save), so the tax burden in these areas is higher and is decreasing as income increases.

On the other hand, life cycle approach emphasizes other aspects are not minor. From more intuitive side, we know that saving some extent this is a demand for future consumption, so resources are not taxed in this period it will be revealed as the real intention of consuming.

In this sense, from a safe definition of wealth W as equation 3 (along the life cycle, the individual will consume their entire revenue stream, all This present value), quickly reached the present value of taxes paid to consume is defined by equation 4, which shows that in this world simplified the tax burden VAT is constant for all individuals regardless of their level of consumption or savings, and in this case is equivalent to the average tax rate k . Whereupon, according to the intertemporal approach VAT is neutral.

Exercise naive

The simplest simulation is to assess the impact of a consumption tax with an average tax rate of 21%, modeling consumption so as to capture the stylized fact described in the previous section. Thus, we use the values \u200b\u200bof average household income per capita by decile (borrowed from here ) as a variable of "welfare." Then, for each decile consumption poses a linear function of income, allowing for heterogeneity in the marginal propensity to consume. Thus, for a given period consumption decile i is defined by

For the definition of the parameters in (5) was taken into account own estimates of the marginal propensity to consume from aggregate data on consumer spending and output in Argentina, while the constant adjusted so that the poorest decile consume their entire income (without loss of generality, so the rest of the deciles consume a smaller proportion of income). Table 1 presents the results of the exercise.

Thus, we see that the average tax rate is decreasing each decile. This is the conventional argument when considering the regressivity of VAT.

But what happens if we extend the exercise to more periods? The result obtained in this framework is simplified to the point that maintaining this structure, after a few periods the regressivity of the VAT reduced considerably if we calculate the tax burden in present value terms. Non so dizzy table presented in the following graph the results to assess the cumulative tax burden (defined as the ratio of present value of tax income to present value) to different time periods.

And here appears a very interesting result: expanding the horizon of analysis 'mitigate' the regressivity of the VAT, even in a context in which the richest deciles do not end up consuming all their wealth (for example, if we omit the constant in each time decile 10 consumed 68% of their income). Thus, if we consider the present and the two nearest future periods, the tax burden rises decile 10 14.3% to 18%. Therefore, although the neutrality of VAT in this case occurs as a result 'asymptotic', the main conclusion is that the strong regressive view initially decreases rapidly taking a few periods ahead.

Of course, this exercise is somewhat naive in that does not involve any decision-making by the agents, nor why the agents explicitly save (or in what form). In the next post, we will investigate the matter.