consumed (because this VAT cannot be captured by an analysis based on data from a single year).<sup>25</sup> Because savings rates tend to increase with income, this biases income-based VAT burden results downwards at higher income levels – driving the finding that the VAT is regressive.

In contrast, studies that measure VAT burdens as a proportion of expenditure (across either the income or expenditure distribution) tend to find that VAT systems are relatively proportional, or even slightly progressive (see, e.g., Thomas, 2022a; Bird and Smart, 2016; IFS, 2011a; Metcalf, 1994). The largest crosscountry study favoring the expenditure-based approach is Thomas (2022a), who finds the VAT to be either roughly proportional or slightly progressive in 23 of 27 OECD countries examined. However, results for four countries show that broad-based VAT systems with very few reduced VAT rates or exemptions can produce a small degree of regressivity.

Most recently, Bachas et al. (2023) have considered the impact of informality in developing countries on the distribution of VAT burdens. They estimate informality Engel curves (relating the informal budget share to log total expenditure) for 32 low and middle-income countries. They find that informality decreases as household expenditure increases, and conclude that this will create a degree of progressivity in the VAT in developing countries. Similarly, Jenkins et al. (2006) find that informality creates progressivity in the VAT in the Dominican Republic.

# 4.1.2 The ability of reduced VAT rates to target poorer households

A number of empirical studies examine who benefits from reduced rates, finding the VAT to be a poorly targeted tool for supporting poorer households. For example, two large scale studies consider who benefits from reduced VAT rates in nine European (IFS, 2011a) and 20 OECD countries (OECD/KIPF, 2014). Both studies find that reduced VAT rates as a whole have a progressive impact, but that richer households benefit more in aggregate terms than poorer households. IFS (2011a) emphasize a key reason for the overall progressive results is the application of reduced rates to the majority of food in all nine countries. OECD/KIPF (2014) finds significant variation in the distributional impact of reduced rates across expenditure types. Reduced rates typically introduced to achieve distributional goals – such as on food, water supply and energy products – are found to have a small progressive effect, but to be poorly targeted. Reduced rates typically introduced to address social, cultural and other non-distributional goals – such as reduced rates on books, restaurant food and hotel accommodation – are often found to be so poorly targeted that they have a regressive effect.<sup>26</sup> Meanwhile, Warwick et al. (2022) examine the overall distributional impact of reduced VAT rates in six developing countries (Ethiopia, Ghana, Senegal, Sri Lanka, Uzbekistan and Zambia). Additionally, they utilize input-output tables to estimate tax expenditures resulting from VAT exemptions. They find both progressive and regressive results, depending on the country, but that reduced rates and exemptions give significant benefit to richer households and are therefore an expensive way of attempting to support poorer households.<sup>27</sup> The impact of informality in developing countries illustrated by Bachas et al. (2023)

> 25 Similarly, current expenditure, and the VAT incurred on it, may have been funded from income earned in a previous year. See Thomas (2022a) for a more detailed discussion.

> 26 A range of other single-country microsimulation studies find similar results either for reduced VAT rates as a whole or for selected reduced rates such as on food (e.g., Davis and Kay, 1985, for the United Kingdom; Leahy et al., 2011, for Ireland; Caspersen and Metcalf, 1994, for the United States; Creedy, 2001, for Australia; Ball et al., 2016, for New Zealand; Cseres-Gergely et al., 2017, for Hungary; and Gaarder, 2018, for Norway). See Thomas (2020) for a detailed review of this literature.

> 27 Warwick et al. (2022) assume a constant degree of informality across households in their base scenario. In sensitivity analysis for Senegal, they vary the degree of informality across households and products, based on place of purchase data (as used by Bachas et al., 2023). This has only a small impact on their results, and their conclusions

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