Reassessing the regressivity of the VAT
This paper reassesses the often-made conclusion that the VAT is regressive, drawing
on tax microsimulation models constructed for an unprecedented 27 OECD countries.
The paper first assesses the competing methodological approaches used in previous
distributional studies, highlighting the distorting impact of savings patterns on
cross-sectional analysis when VAT burdens are measured relative to income. As argued
by IFS (2011), measuring VAT burdens relative to expenditure – thereby removing the
influence of savings – is likely to provide a more meaningful 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, 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. In
the broader context of the COVID-19 crisis, the findings of the paper suggest there
may be scope in many countries for VAT reform to help address revenue needs, as this
revenue may be generated with less significant distributional effects than previously
thought. While standard VAT rates are high in many countries, OECD evidence shows
that scope exists to broaden VAT bases. Nevertheless, any VAT increases, including
VAT base broadening measures that impact the poor, should be accompanied by compensation
measures for poorer households, such as targeted tax credits or benefit payments.
Published on August 10, 2020
In series:OECD Taxation Working Papersview more titles