Recent OECD research highlights the potential growth benefits of shifting the tax mix towards consumption taxes. In particular, there is a strong case for countries to broaden their value-added tax (VAT) bases, not just to raise revenue, but to reduce the substantial compliance costs and distortions to consumption decisions that arise from multi-rate VAT systems. In practice, however, governments have often been reluctant to embrace VAT base broadening measures because of a range of concerns. Foremost of these is the widely held view that the poor are hit hardest by increases in standard and reduced VAT rates.

The OECD’s 2008 Taxation and Economic Growth study highlighted the potential growth benefits of shifting the tax mix away from taxes on labour and corporate income towards consumption taxes. In particular, there is a strong case for countries to broaden their value-added tax (VAT) bases, not just to raise revenue, but to reduce the substantial compliance costs and distortions to consumption decisions that arise from multi-rate VAT systems. While a number of countries have recently increased their standard VAT rates, governments have been far more reluctant to embrace VAT base broadening measures because of a range of concerns. Foremost of these is the widely held view that the poor are hit hardest by consumption taxes, and particularly by increases in reduced VAT rates.

This chapter provides a brief introduction to how OECD countries tax consumption. The importance of consumption taxes as a revenue source is first discussed, before the main design features of value-added tax (VAT) and excise tax systems are briefly summarised.

This chapter examines the distributional effects of value-added tax (VAT) and excise tax systems in 20 OECD countries. The analysis is based on consumption tax micro-simulation models constructed for each country using household expenditure micro-data. Results show that VAT systems are regressive when measured as a percentage of income, but are generally either proportional or slightly progressive when measured as a percentage of expenditure. Total excise tax burdens (on alcohol, tobacco and transport fuels) are shown to be almost always regressive when measured as a percentage of income, and in most cases to be either regressive or roughly proportional when measured as a percentage of expenditure. In interpreting these results, the report argues that an income-base approach may be of interest in analysing the immediate distributional effects of consumption taxes, but that an expenditure-base approach will provide a more reliable measure of the lifetime distributional effects. The results therefore challenge the general public perception that VAT systems are regressive, at least in a lifetime context. That said, results for Estonia, New Zealand and the Slovak Republic highlight that broad-based VAT systems that have few reduced VAT rates or exemptions can still produce a small degree of regressivity when expenditure is used as a proxy for lifetime income. Meanwhile, results for Chile, the Czech Republic, Korea and the Slovak Republic show that excise taxes can in some cases be progressive in a lifetime context.

This chapter uses the micro-simulation models developed in Chapter 2 to investigate how effective reduced value-added tax (VAT) rates are at supporting poor households. The micro-simulation models are used to estimate the tax expenditures received by different households from different reduced VAT rates by simulating the revenue effects of removing these concessions. The results show that most, if not all, of the reduced VAT rates that are introduced for the distinct purpose of supporting the poor – such as reduced rates on food, water supply and energy products – do have the desired progressive effect. However, despite this progressive effect, these reduced VAT rates are still shown to be a very poor tool for targeting support to poor households: at best, rich households receive as much aggregate benefit from a reduced VAT rate as do poor households; at worst, rich households benefit vastly more in aggregate terms than poor households. Furthermore, reduced rates introduced to address social, cultural and other non-distributional goals – such as reduced rates on books, restaurant food and hotel accommodation – often provide so large a benefit to rich households that the reduced VAT rate actually has a regressive effect. These results suggest the need for a careful, case-by-case reassessment of the relative merits of various reduced VAT rates in many countries.

This chapter introduces the value-added tax (VAT) and excise tax systems in Korea, examines VAT revenue ratios across OECD member countries, and estimates the VAT burden of Korean households utilising the Household Income and Expenditure Survey of Statistics Korea and the consumption tax micro-simulation model of the OECD. Korea’s VAT revenue ratio is relatively high amongst OECD countries at around 70%, with this largely attributable to the single rate system with a low standard rate. Meanwhile, by comparing the VAT burden ratios to income or expenditure across income or expenditure deciles, we observe that the distribution of the burden ratios may vary significantly across different combinations of ratios and deciles. Therefore, it may be misleading to rely on a specific measure of the VAT burden ratio, such as the VAT burden ratio to income across income deciles. It is necessary to assess the policy effects of the VAT by comparing multiple measures of policy indicators.