On Selective Indirect Tax Reform in Developing Countries
M. Shahe Emran
George Washington University - Department of Economics
Joseph E. Stiglitz
Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)
April 21, 2011
Journal of Public Economics, Vol. 89, No. 4, 2005
The current consensus on indirect tax reform in developing countries favors a reduction in trade taxes with an increase in VAT to raise revenue. The theoretical results on selective reform that underlie this consensus are, however, derived from partial models that ignore the existence of an informal economy. Once the incomplete coverage of VAT due to an informal economy is acknowledged, we show that, contrary to the current consensus, the standard revenue-neutral selective reform of trade taxes and VAT reduces welfare under plausible conditions. Moreover, a VAT base broadening with a revenue-neutral reduction in trade taxes may also reduce welfare. The results raise serious doubts about the wisdom of the indirect tax reform policies pursued by a large number of developing countries.
Accepted Paper Series
Date posted: April 25, 2011
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