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Seminar in Economics with Lucie Gadenne

Lucie Gadenne, University of Warwick

Informality, Consumption Taxes and Redistribution

ABSTRACT:

Can consumption taxes be progressive in developing countries? In this paper we assemble expenditure surveys from 30 countries at different levels of economic development  to study how the existence of large informal sectors and the shape of product-specific Engel curves affect the redistributive potential of taxation. Using the place of purchase to proxy for informal sector consumption enables us to characterize Informality Engel Curves (IECs): we find that the budget share spent in the informal sector steeply declines with income in all countries.  We then extend the standard optimal commodity tax model to allow for an informal sector and calibrate it to our data. We find that optimal uniform rates decrease with development, while relative tax subsidies on food products increase with development. Overall, the informal sector makes consumption taxes progressive: we find that on average households in the richest quintile face an effective tax rate that is 2.5 times higher than that of the poorest quintile. Optimally differentiating rates on food versus non-food products only marginally increases progressivity, especially in the poorest countries.  

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