The purpose of this paper is to address two fundamental issues in indirect tax design. It first revisits the case for reduced rates on items especially important to the poor, and then explores the welfare costs from cascading taxes.
Applied theory was used in this paper.
On the first issue, the paper establishes conditions under which even very crudely targeted spending measures better serve the interests of the poor than does the reduced taxation of particular commodities looming large in their consumption. On the second, it shows that these may actually be lower the wider the set of inputs that are taxed but, more to the point, may plausibly be large even at a low nominal tax rate and with relatively few stages of production: contrary to a common mantra, “a low rate on a broad base” is not always good policy.
Both issues addressed in the paper are recurrent and central concerns in the design of indirect taxes in general, and the value-added tax (VAT)/general sales tax (GST) in particular. The author is unaware of other treatments that are at all comparable in perspective or results. The author hopes the analysis will prove useful in many contexts where these issues arise – not least in India, where these issues are central to discussions of VAT/GST reform.
©International Monetary Fund. The views presented in this article are those of the author and should not be attributed to, or reported as, reflecting the position of the IMF, its Executive Board,or any other organization mentioned herein.
This is a revised version of the Third Dr Raja J. Chelliah Memorial Lecture, “Some Current VAT Issues”, delivered in New Delhi on February 9, 2012. The author is grateful to Govinda Rao for the kind invitation to deliver this lecture; to him, Kavita Rao and others of the National Institute of Public Finance and Policy for their generous hospitality and comments on this work; to David Coady for many helpful suggestions; and to three referees and a co-editor for their careful review. The views expressed here remain mine alone, and should not be attributed to the International Monetary Fund (IMF), its Executive Board or its management.
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