The Value Added Tax and Growth: Design Matters

Abstract

Does the design of a tax matter for growth? Assembling a novel dataset for 30 OECD countriesover the 1970-2016 period, this paper examines whether the value added tax (VAT) may havedifferent effects on long-run growth depending on whether it is raised through the standard rateor through C-efficiency (a measure of the departure of the VAT from a perfectly enforced taxlevied at a single rate on all consumption). Our key findings are twofold. First, for a given totaltax revenue, a rise in the VAT, financed by a fall in income taxes, promotes growth only whenthe VAT is raised through C-efficiency. Second, for a given VAT revenue, a rise in Cefficiency,offset by a fall in the standard rate, also promotes growth. The implication is thusthat in OECD countries broadening the VAT base through fewer reduced rates and exemptionsis more conducive to higher long-run growth than a rise in the standard rate.

Keywords: Tax revenue, Tax evasion, Revenue measures, Tax collection, Income taxes, VAT, Economic growth, Standard rate, C-efficiency, Base broadening, long-run, PMG, long-run growth

JEL Classification: E62, H20, O47, E01, H71, H2, H83, K34