UBI and VAT are proven to solve inequality – either on their own is insufficient

7. Discussion and conclusions This paper has used microsimulation models and input–output tables to estimate the impact of preferential VAT rates on tax revenues, poverty and inequality in six LMICs (Ethiopia, Ghana, Senegal, Sri Lanka, Uzbekistan and Zambia), and compared these impacts to existing and hypothetical cash transfer programmes. We find that preferential VAT treatments (excluding exemptions that have strong administrative justifications, such as for public services, financial services, accommodation costs and small businesses) are a poor way of channelling resources towards poor households. Although in isolation these preferential rates do reduce poverty, and potentially sometimes by a significant amount, they are very expensive and much of their benefit accrues to better off households. This is partly because monetary expenditure is relatively less important for low-consumption households (who obtain more from home production) in the LMIC context, and thus exemptions have less of an impact for such households than they would if all consumption was comprised of monetary expenditure. However, much more important is the rather banal fact that high consumption households spend more in cash terms on exempt and reduced rate goods and services. This means that the implicit cash subsidy afforded to high-consumption households is far greater, on average, and renders preferential VAT rates an expensive way of attaining a given level of poverty reduction. Although we cannot generalise this conclusion to other country contexts with certainty, the consistency of the result in the six countries studied – which have different levels of income, inequality and tax structures – leads us to believe that similar patterns should be expected in other LMICs, mirroring similar findings in the OECD and EU. Only if preferential VAT rates are targeted narrowly on goods and services consumed in greater absolute quantities by the poor would the overall qualitative conclusion be overturned. Existing cash transfer schemes are better targeted at poor households towards the bottom of the consumption distribution. However, they may not always provide a suitable means of compensating households for the reduction in purchasing power they would face if the VAT base was broadened. Many existing schemes remain relatively small-scale and tend to target subsets of the poorest parts of the population, often based on specific demographic or geographic eligibility criteria, even before accounting for potential exclusion (and inclusion) errors. Significant increases in the scale and coverage of such schemes would be required to offset the negative impact of VAT base broadening on households with low and middling levels of consumption. In these countries, that is sometimes those below or close to the $1.90 and $3.20 international poverty lines. A Universal Transfer (UT) would overcome coverage issues in existing cash transfer schemes. Simulating a counterfactual policy scenario in a comparable way in each of the countries considered, our results indicate that broadening the VAT base and using the revenue to fund a UT would boost the consumption of the least well-off households, reducing inequality and measures of extreme poverty in all cases. Our focus on a UT is primarily due to its simplicity and comparability across countries, allowing us to highlight the possible gains for poorer households from one policy option in different contexts. However, while governments are able to choose from a range of redistributive instruments, a UT would appear to have a number of desirable features. No sophisticated targeting would be required, in principle no vulnerable households would be excluded, and the inclusion of the middle class might be a boon to political feasibility. There are of course questions of practicality -2.0 -1.8 -1.6 -1.4 -1.2 -1.0 -0.8 -0.6 -0.4 -0.2 0.0 Ethiopia Ghana Senegal Sri Lanka Uzbekistan Zambia cirt e mytil auqeni ni egnah C Gini index 90/10 ratio Figure 6.2. Estimates of the impact on inequality from a uniform VAT funding a UT. Note: Inequality measures are calculated based on consumable income per capita pre- and post-reform. Source: Author’s calculations using GHATAX, ETHTAX and CEQ/World Bank fiscal incidence analysis. R. Warwick, T. Harris, D. Phillips et al. World Development 151 (2022) 105742 14 with regards to the ability of LMIC governments to administer such nationwide programmes, although the technology required is increasingly available (Ghana, for instance, has been distributing biometric ID cards to its population (Thiel, 2020)).