Informality, Consumption Taxes and Redistribution

Abstract

Can taxes on consumption redistribute in developing countries? Contrary to consensus, we show that taxing consumption is progressive once we account for informal consumption. Using household expenditure surveys in 32 countries we proxy for informal consumption using the type of store where purchases occur. We find that the budget share spent in informal stores steeply declines with income, so that the effective tax rate of a broad consumption tax rises with income. Our findings imply that the widespread policy of exempting food from taxation cannot be justified on equity grounds in low-income-countries.