range of recreational and cultural expenditure. He finds that these reduced VAT rates would be far less effective at supporting poorer households than the existing targeted family tax credits.

Van Oordt (2018) uses a QUAIDS model for South Africa to simulate removing reduced VAT rates and using the revenue to extend existing cash transfers. He finds that low- and middle-income households would benefit from the reform, while high-income households would lose. However, he highlights some concerns regarding the ability to effectively implement cash transfers in a developing country context. In this regard, Gcabo et al. (2019), in their non-behavioral analysis, find that better targeting would be achieved with the introduction of new cash transfers rather than the extension of existing cash transfers in South Africa.

Warwick et al. (2022) find that the existing cash transfer programs in their six developing countries are better targeted at poor households than reduced VAT rates and exemptions. That said, the targeting of these programs remains imperfect, and would require significant improvements in both generosity and coverage in order to compensate for base-broadening VAT reforms. Strikingly, their non-behavioral simulation results show that even adopting a universal benefit would better target poor households than the reduced VAT rates (and exemptions) in place in these countries.<sup>31</sup> In addition to redistribution (which addresses vertical equity concerns), there are also horizontal equity implications to the adoption of reduced VAT rates. As noted by IFS (2011b), multi-rate VAT systems will effectively reward some households for their preferences and penalize others. This will breach horizontal equity as, for example, two otherwise identical households with different consumption preferences for reduced vs standard-rated goods and services, will face different VAT burdens. In contrast, a single-rate VAT system would result in the same tax burden for both households, irrespective of their consumption preferences.<sup>32</sup> Finally, the application of reduced VAT rates for distributional purposes may conflict with other policy objectives. In particular, applying reduced VAT rates on fossil fuel energy use (e.g. heating fuels) will conflict with environmental goals to efficiently price carbon emissions (and internalize other negative externalities, e.g., local air pollution). A preferable approach is to fully internalize the negative externalities in the price through excise and/or carbon taxes, apply the standard VAT rate on top, and then provide compensation to poorer households through targeted cash transfer programs.<sup>33</sup> More generally, with any good producing negative externalities (e.g. tobacco, alcohol), the standard VAT rate should be imposed on top of the corrective excise tax used to internalize the externality.

> 31 Non-behavioral studies for the United Kingdom by Davis and Kay (1985), Crawford et al. (2010) and Mirrlees et al. (2011) find reform packages involving the replacement of reduced VAT rates with changes to direct taxes and transfer payments can improve distributional outcomes. Similarly, Brashares et al. (1988) find that income-tested credits or reimbursements would benefit poor households far more than zero-rating necessities in a VAT in the United States. Again, see Thomas (2020) for a more detailed review of this literature.

> 32 IFS (2011b) also discuss the specific egalitarianism argument of Tobin (1970). This argument supposes that society has preferences regarding inequality in the consumption of specific products – such as necessities – as opposed to over total consumption. However, as they note, this argument assumes that households would buy too little of the product if they were provided with the money to buy them (e.g. through a tax credit or benefit). As such, it is more in the nature of a merit good or internality argument, rather than an equity-based argument.

33 The same rationale also applies regarding temporary measures introduced in response to the recent surge in food and energy prices, with targeted cash transfers (whether implemented via the tax or benefit system) being preferable to reduced VAT rates or other price-based support measures (see, e.g., Amaglobeli et al., 2022; Van Dender et al., 2022).

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