Informality, Consumption Taxes and Redistribution

Can consumption taxes reduce inequality in developing countries? We combine household expenditure data from 31 countries with theory to shed new light on the redistributive potential and optimal design of taxes. use type store which purchases occur proxy for informal (untaxed) consumption. This enables us characterize informality Engel curve: we find that budget share spent sector steeply declines income, all countries. The thus makes progressive: households richest quintile face an effective tax rate is twice poorest quintile. extend standard commodity model allow calibrate it study effects different policies inequality. Contrary consensus, show are redistributive, lowering by as much personal income Once taken into account, commonly used policies, such reduced rates necessities, have a limited impact In particular, subsidizing food cannot be justified equity or efficiency grounds several poor countries. Institutional subscribers NBER working paper series, residents may download this without additional charge at www.nber.org.