What role in improving macro performance? Fiscal devaluation Is - - PowerPoint PPT Presentation

THE VAT—EQUITY, POLITICS AND MACROECONOMICS

Michael Keen

OECD Global Forum on VAT, Tokyo

April 18, 2014

Focus on two sets of issues:

• How to reconcile effectiveness of VAT as revenue

source with distributional concerns?

• What role in improving macro performance?

– ‘Fiscal devaluation’ – Is the VAT (relatively) growth friendly’?

DISTRIBUTIONAL POLICY AND THE VAT

Policy arguments for differential rates

• Efficiency

– Lower rates where this encourages paid labor

• Child care?

– But empirical evidence weak, so leave this aside

• Distribution

– Lower rates on items important to the poor

But ….

Two steps….

....to rejecting reduced rates on equity grounds

• Step One: Reduced rates are very a badly

targeted way of helping the poor

– the poor spend a larger proportion of their income on (say) food, but the rich spend absolutely more

For instance, zero rate on food in Mexico:

I II III IV V VI VII VIII IX X Percent of total subsidy Percent of income 5 10 15 20 25

But this in itself does not prove reduced rate undesirable—also need:

• Step Two: Show there is some other,

better way to protect the most vulnerable

This will very often be the case in advanced

• economies. In the UK for instance,….

Eliminating zero rate and increase benefits—

poor better off, and net revenue gain

• £30.00
• £25.00
• £20.00
• £15.00
• £10.00
• £5.00

£0.00 £5.00 £10.00 1 2 3 4 5 6 7 8 9 10 Income deciles Average Tax Gains/Losses (£'s p.w.)

• 9.00%
• 7.50%
• 6.00%
• 4.50%
• 3.00%
• 1.50%

0.00% 1.50% 3.00% Average Tax Gains/Losses (% of disposable income) Average Tax Losses (£'s p.w.) Average Tax Losses (% of disposable income)

• What about developing economies?

Only blunter spending instruments available, so policy case for differentiation stronger—but how strong? Poorest gain from increasing rate on ‘food’ if and

• nly if:

Proportion of all food they consume Exceeds Their marginal benefit from $1 of public expenditure

For instance:

• Gain if revenue raise used to pay a poll subsidy
• In India example below, bottom 20 percent benefit from

increased spending on curative health care if they account for less than 10 percent of ‘food’ consumption

10.1% 13.4% 17.8% 25.6% 33.1%

0.0% 10.0% 20.0% 30.0% 40.0% Poorest 20% 2nd Middle 20% 4th Richest 20%

The moral is:

• Rate reductions are so badly targeted on

poor that spending doesn’t have to be very well targeted to be a better way to help them

So why are reduced rates so common?

...especially for older VATs:

Number of new VATs Proportion born with a single rate Before 1990 48 25% 1990-1999 75 71% 1999-2011 31 81%

• Governments’ lack of

understanding/communication?

– especially latter

Transparency alone not enough

• Resistance from higher income groups

– May understand very well!

• Signals how much policy makers care about

poor, precisely because it is inefficient

– A bit subtle….

• Doubts that compensation will be paid

– Iran subsidy example: cash up front – Earmarking as a solution?

• Examples: Ghana, proposed for US VAT
• But either (a) constrains spending or (b) is misleading and

non-transparent

A last resort?

• Hold out for even more progressive ways to

finance same spending

Successes?

• Crisis hasn’t helped: For 28 advanced since 2009
• Moral: Mistakes are hard to correct!

VAT increases Social contribution cuts

17 3

15 1 2

FISCAL DEVALUATION

What is it?

With fixed exchange rate, tax changes can mimic a devaluation:

• A fiscal devaluation is a reveneu-neutral shift

from employer’s social contributions (SCR) towards consumption taxes (especially VAT)

How does it work in principle?

At fixed exchange rate:

• Lower SCR reduces foreign currency price of exports
• Consumer prices of domestically produced goods

unchanged: higher VAT offsets lower SCR

• Consumer prices of imports rise due to higher VAT

NB: Expect effect to be temporary, especially where exchange rate flexible

Does it work in practice?

For a panel of 30 OCED countries over 40 years, results not entirely robust but suggest:

• For euro countries, a shift from SCR to VAT of
• ne percentage point of GDP might raise net

exports by 3 to 4 percent in short run

– Effect is temporary but quite long-lasting

• Less marked for non-euro/flexible ER countries

Impact on net exports over time (in % GDP)

• 4
• 2

2 4 6 8 10 1 6 11 16 21 26 31 36 41 46

Effect on net exports in percent of GDP

Point estimate

Policy implications?

• Few have done FD in the crisis

– Many have increased SCRs

Why?

• Significant additional considerations

– Compensating e.g. pensioners reduces funds available to cut SCR – Maintain contributory principle

• May need big tax switch to have marked effect

– And hence risky

But:

• Even if no effect on net exports, end up with

more growth friendly tax system

– Evidence that heavier reliance on VAT associated with faster growth

• Though structure must matter—with signs that base

broadening better for growth than rate increase