Consumption Taxes: Their Ramifications for Income Distribution

The distribution effects or incidence of consumption taxes such as the Value Added Tax (VAT), Goods and Services Tax (GST) remains a contentious issue. Three aspects have to be distinguished. First is the approach of distribution studies that tends to yield a result of regressivity; second is the computable general equilibrium (CGE) approach that views redistribution as one of =incidence‘ among factors of production, in effect, subsuming the distribution of burdens among consumers; and third is the examination of distribution effects over a life cycle that finds the VAT-GST to be mildly progressive. A review of the literature indicates that it is difficult to demonstrate that the VAT is not regressive or adverse for income distribution unless accompanied and countered by a redistributive expenditure package. Countries nevertheless opt for the VAT-GST since it is simple to design and administer, its compliance is believed to be higher than for the income tax, its compliance cost for the taxpayer is lower, and its revenue generating capacity is higher and more certain. The United States remains the only major economy that has not yet introduced a VAT-GST. Even though VAT proposals exist, apprehension regarding its distribution effects in no small way has acted as a barrier. For India, which is preparing to introduce a comprehensive GST comprising central and state government levels, distributional neutrality in the GST‘s ramifications remains a crucial element in its appropriate design. [ICRIER Policy series No.8]. URL:[http://www.icrier.org/pdf/Policy_Series_No_8.pdf].