On Selective Indirect Tax Reform in Developing Countries
41 Pages Posted: 22 Oct 2002
There are 2 versions of this paper
On Selective Indirect Tax Reform in Developing Countries
On Selective Indirect Tax Reform in Developing Countries
Date Written: June 2002
Abstract
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 widely implemented indirect tax reform in developing countries.
Keywords: Tax reform, VAT, Trade tax, Informal economy, Welfare, Government revenue
JEL Classification: F13, H20
Suggested Citation: Suggested Citation
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