Value Added Tax increase the number of individuals bellow the poverty line

This paper has used a household expenditure microdata set of unprecedented size to examine the distributional effects of the VAT in 27 OECD countries. It has followed a consistent microsimulation methodology across countries to ensure comparability of results.

Average tax rate results presented across disposable income and expenditure deciles broadly confirm the dichotomous results from previous smaller-scale studies: the VAT appears to be regressive when measured as a percentage of current income in all 27 countries, but appears generally either proportional or slightly progressive when measured as a percentage of current expenditure. The paper has illustrated the misleading effect of savings behaviour on results when measured as a percentage of income, showing that expenditure-based results provide a more reliable means of assessing the distributional effect of the VAT. Expenditure-based Kakwani progressivity index results confirm a low degree of progressivity in almost all countries, often extremely close to proportionality. The exceptions are Chile, Hungary, Latvia and New Zealand where a very small degree of regressivity is found.

The paper also examines the effect of the VAT on the poor by calculating a range of FGT poverty indices. Based on a relative poverty line of 50 per cent of median equivalised gross expenditure, the results show that the imposition of VAT increases the number of individuals below the poverty line (the poverty headcount) by three percentage points, on average, from 8.1 per cent to 11.1 per cent. Calculations of the poverty gap and squared poverty gap indices also show similar increases.

Overall, the paper finds that the VAT is generally either roughly proportional or slightly progressive, with this progressivity driven by the presence of reduced VAT rates and exemptions. This strongly contrasts with the general public perception that VAT systems are regressive. Nevertheless, the results for Chile, Hungary, Latvia and New Zealand highlight that broad-based VAT systems that have few reduced VAT rates or exemptions can still produce a small degree of regressivity.

Furthermore, the results clearly show that even a roughly proportional VAT can have significant equity implications for the poor. 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.