Equity Aspects of VAT in Serbia. Milojko Arsić, Faculty of Economics, Belgrade Nikola Altiparmakov, Faculty of Economics, Belgrade

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1 Equity Aspects of VAT in Serbia Milojko Arsić, Faculty of Economics, Belgrade Nikola Altiparmakov, Faculty of Economics, Belgrade

2 Tax Equity vs. Tax Efficiency Tax equity considerations date back to Ancient Egypt, much before economic considerations Direct income taxes were considered equitable, while indirect consumption taxes (VAT) were deemed inequitable Economic efficiency: Income taxes more damaging to economic growth than Property and Consumption taxes

3 Why were consumption taxes deemed inequitable? Common belief: poor people consume more of their income than rich individuals Kuznets puzzle and failure of simple Keynesian consumption function Inter-temporal model of consumption (Fisher) Life-cycle Hypothesis (Modligiani) Permanent Income Hypothesis (Friedman) Maybe demise of Keynesian consumption function naturally lends itself to demise of inequitable VAT belief?

4 Microsimulations approach Take micro-level expenditure survey data Group data into different categories (standard VAT rate vs. reduced VAT rate vs. VAT exempt) Apply appropriate tax rate to each category Experiment with different tax rates (full forward-shifting, static analysis, no behavioral changes) Perform income ranking, calculate summary statistics, Gini coefficients, etc.

5 Horizontal equity considerations Tax incidence studies focus on vertical equity issues, ignoring horizontal equity Shadow economy and tax evasion profoundly effect horizontal tax equity Especially important when comparing equity between VAT and income taxes

6 Annual VAT incidence estimates Income Decile VAT / Income % % % % % 6 9.9% % 8 9.1% 9 8.7% % Global progressivness indices before tax after tax % change Gini % GE(0.2) % GE(2.0) %

7 Consumption patterns over annual income deciles Income Decile Standard VAT Rate Reduced VAT Rate VAT Exempt Natural consumption % 40.8% 2.4% 10.3% % 39.0% 2.6% 9.7% % 40.3% 2.1% 8.1% % 38.9% 2.1% 9.0% % 39.5% 2.0% 7.1% % 39.8% 2.0% 6.5% % 39.1% 2.2% 4.3% % 39.7% 3.5% 4.0% % 36.9% 3.8% 3.9% % 34.6% 3.4% 3.9%

8 Saving patterns over annual income deciles Income Decile Savings / Income Implicit income from natural consumption / Income Savings / Monetary Income % 17.8% -88.9% % 12.2% -29.1% % 9.4% -17.5% 4-4.0% 9.3% -4.4% 5 6.7% 6.6% 7.2% 6 8.6% 5.9% 9.2% 7 9.9% 3.8% 10.3% % 3.3% 17.9% % 3.0% 23.1% % 2.5% 36.9%

9 Effective VAT rate One would expect that effective VAT rate is between 0% and standard VAT rate for all households Effective VAT rate for lowest income decile in Serbia is 21.2%, tangibly higher than standard VAT rate of 18% Effective VAT rate in lowest income decile is tangibly higher than standard VAT rate in 80% of EU countries investigated by O Donoghue (2004) and DeCoster (2010)

10 Literature on lifetime tax incidence Annual incomes are not relevant measure of welfare for lifetime tax incidence Poterba (1989), Fullerton & Rogers (1991), Caspersen & Metcalf (1994) Need to look at lifetime measures of income or permanent income indicators Use current consumption as proxy for permanent (lifetime) income

11 Annual vs. Lifetime Income Rankings Deciles by Expenditure Ranking % 16.1% 10.5% 8.9% 7.4% 4.6% 2.2% 3.5% 3.1% 2.0% Deciles by Income Ranking % 21.8% 13.7% 11.1% 8.9% 7.4% 5.9% 3.7% 2.8% 1.5% % 16.6% 18.3% 14.6% 9.4% 7.8% 7.6% 5.7% 4.4% 3.1% % 16.6% 13.5% 15.3% 10.5% 6.5% 10.5% 7.8% 4.6% 4.4% 5 5.0% 12.2% 15.3% 11.3% 12.9% 14.4% 10.0% 9.8% 6.3% 2.8% 6 2.6% 5.4% 10.9% 15.0% 15.5% 14.4% 12.0% 10.5% 8.9% 4.8% 7 2.0% 5.0% 5.9% 9.4% 15.0% 13.5% 14.4% 13.7% 11.8% 9.4% 8 0.7% 2.8% 5.4% 7.6% 11.5% 15.3% 14.6% 15.5% 15.7% 10.9% 9 0.7% 2.8% 5.0% 4.1% 6.3% 8.9% 13.3% 17.0% 21.4% 20.5% % 0.7% 1.5% 2.6% 2.6% 7.2% 9.6% 12.9% 21.1% 41.2%

12 Lifetime VAT incidence in Serbia Permanent Income Decile VAT / Permanent Income % % % % % % % % % % Global progressivness indices before tax after tax % change Gini % GE(0.2) % GE(2.0) %

13 Consumption patterns over permanent income deciles Permanent Income Decile Standard VAT Rate Reduced VAT Rate VAT Exempt Natural consumption % 42.5% 0.6% 13.4% % 38.5% 1.0% 11.8% % 39.6% 1.0% 11.2% % 41.6% 1.4% 7.8% % 41.6% 1.4% 7.9% % 40.4% 1.9% 6.2% % 40.5% 2.6% 5.2% % 38.8% 3.1% 5.3% % 38.6% 3.0% 3.7% % 32.5% 5.4% 2.5%

14 (In)efficiency of multiple VAT rates Atkinson and Stiglitz (1976) show that taxing consumption with single tax rate and no product differentiation -- is optimal Consumption patterns shown earlier are relative to one s (permanent) income, and are not in absolute nominal values

15 Reduced VAT rate subsidies Permanent Income Deciles Bread and baked products Milk and dairy products Meat and fish Medicines Utility Services 1 1,237 1,125 1, ,375 1,538 2, ,355 1,789 2, ,496 2,010 3, , ,634 2,264 4,259 1,082 1, ,637 2,410 4,645 1,272 1, ,738 2,553 5,290 1,447 1, ,787 2,736 5,883 1,506 1, ,802 3,117 7,299 1,835 2, ,097 3,650 9,614 2,350 2,501

16 Efficiency-driven tax reform Scenario 1: Single VAT rate at 18% Scenario 2: Increase standard and reduced VAT rates by 4% Scenario 3: Increase standard and reduced VAT rates by 2%, move half of g&s from reduced to standard rate All scenarios yield same revenues, 2.5% of GDP Scenario 1 is slightly regressive, Scenarios 2 and 3 are slightly progressive

17 Conclusions VAT in Serbia can not be considered an inequitable tax, especially due to high evasion of direct income taxes Significant own-source farming production represents VAT-exempt buffer for low-income households Well targeted public expenditures are best suited for achieving equity and income redistribution goals