Transcript Distributional Impact of VAT Reform in the Dominican

Distributional Impact of VAT
Reform in the Dominican Republic
By Anna Fruttero and Omar Arias
LCSPP
Frontiers in Practice
Reducing Poverty Through Better Diagnosis
Analyzing Fiscal Impacts on Poverty Reduction
March 23, 2006
1
Background
 PSIA request
from DR Gov in support of
fiscal reform process (tax loss due to
CAFTA, financing of social spending gaps)
 Developed
as part of the 2005 PA in
collaboration with the Technical
Secretariat of the Presidency
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Why interest in VAT (ITBIS) reform analysis ?
VAT is not fully
exploited (exemptions),
Other taxes (income,
property) harder
Public opinion
Regressivity bias:
Need to assess
distributional impact
3
DR tax effort has increased but is still around
LAC average and below similar countries
% taxes in GDP
35
30
% of GDP
25
20
15
10
5
0
DR
CR
ES
U
G
A
HO
* Unweighted regional averages
Note: data for GUA and HO for 99 from CEPAL
For NI, data from 91 and not 90.
Source: World Development Indicators and OECD
NI
PA
m
lA
a
r
nt
e
C
*
ica
r
e
o
st
e
R
*
AC
L
f
D
EC
O
*
1990-1994
i
As
t
s
Ea
a*
Circa 2000
4
DR still relies heavily on trade taxes (though
less so in recent years)
% total revenues circa 2000
60%
50%
40%
30%
20%
10%
0%
Income
G&S
DR
CA*
Property
Rest LAC*
Int'l trade
OECD*
SS
East Asia*
•Regional averages
Source: Based on Government Finance Statistics 2004, IMF and OECD
5
VAT revenues are particularly low
% total revenues
60
50
40
30
20
10
0
PA MX DR VE HA CO BO BR UR CR PY EC
Source: Based on Government Finance Statistics, IMF
NI
CL AR ES PE
6
…Largely a result of low and declining
productivity of the tax (loopholes, evasion)
VAT Rate
VAT productivity
18
80
16
70
14
60
12
50
10
40
8
6
30
4
20
2
10
0
0
CR
1994
DR
Present
ES
GUA
HO
NI
PA
Rest CA
LAC
East OECD
Asia
CR
DR
1994
1997
ES
GUA
HO
NI
PA
CA
Rest
LAC
Present
Source: Government Finance Statistics, International Finance Statistics and World Economic Outlook (IMF)
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VAT is a means to
tax the well off
Other
13%
National
Remittances
6%
Imputed Rent
12%
Labor Income
56%
20% poorest
Sources of
income:
20% richest
Source: authors’ calculations based on
ENCOVI 2004
Overseas
Remittances
3%
Home Selfconsumption
10%
National
Remittances
2%
Other
25%
Imputed Rent
5%
Overseas
Remittances
18%
Labor Income
44%
Home Selfconsumption
6%
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The rich account for more than half of
consumption of exempt goods & services
20% poorest
quintile 2
4.5
8.8
quintile 3
13.2
Distribution of expenditures by quintiles
(%)
20% richest
53.8
quintile 4
19.6
Exempt G&S
20% poorest
2.5
20% richest
65.3
quintile 2 quintile 3
5.5
9.6
Non exempt G&S
Source: authors’ calculations based on
ENCOVI 2004
quintile 4
17.0
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 Exemptions
of G&S from VAT
implicitly subsidize the consumption
of the rich at a significant revenue
loss
 Increasing
revenues from this tax
should come from expanding the tax
base with due equity considerations
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Options to expand the VAT tax base

Remove all exemptions (benchmark)
 Remove all exemptions except for Health,
Education and Electricity (SEE)
 Remove all exemptions except for basic food +
SEE
 Apply a lower rate to basic food, SEE exempt
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To assess distributional impacts for each
scenario we compute:

Tax burden= % total tax paid by each Q
 Tax pressure= tax burden/income share of each Q
 Effective tax rate= total tax paid/total income by Q

By simulating the VAT code with data on incomes
and expenditures from a 2004 household survey
(no behavioral responses)
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All options to broaden the base increase the tax
pressure for the poor but this remains much lower than
for the rich
Ratio of share of tax paid to income share
1.20
1.00
0.80
0.60
0.40
20% poorest
quintile 2
quintile 3
Actual
No exemptions
Basic food/gas/SEE
Rate differentiation
quintile 4
20% richest
SEE
SEE = Health, education and electricity
Source: authors’ calculations based on ENCOVI 2004
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Revenues could increase substantially even
exempting basic food and SEE, or with a
differential tax rate
Revenue estimates (% GDP)
10
9
8
7
6
5
4
3
2
1
0
Actual
No exemptions
Exemption SEE
Exemptions
basic food + SEE
Rate
differentiation
Note: estimates do not account for behavioral responses and only capture private consumption of
households, but account for tax avoidance by small firms
SEE = Health, education and electricity. Source: authors’ calculations based on ENCOVI 2004
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Two BIG caveats
1. Main results were derived under the
assumption that consumption patterns are not
affected by changes in prices…
 Sensitivity analysis using various plausible
values of price elasticities indicate tight orders
of magnitude of the results
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Two BIG caveats
2. Distributional impact of fiscal reform
depends on how spending is distributed…


Less than one third of social assistance $$
reach the poorest 40 percent (helicopter
allocation is better).
Only the high-revenue reforms can generate
transfers significantly higher than the extra tax
burden on the poorest 40% under existing
expenditure allocations.
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Policy implications

DR has room to increase IVA revenues without
too high a cost on equity, by expanding the base
while maintaining exemptions on (or applying a
different rate to) basic food
 To maximize overall equity impacts it is critical to
simultaneously improve targeting of social
expenditures

Although these results were effectively used by
the DR Government in the public debate, lack of
power in congress led to a 1st phase curtailed
reform (maintaining many exemptions).
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