The Equity Impact of the Value-Added Tax in Bangladesh


WP/94/125-EA
The Equity Impact of Value-Added Tax in Bangladesh
by Shahabuddin M. Hossain

This paper examines the income distributional impact of different VAT
schemes on the urban and rural household groups in Bangladesh. It argues
that, among the existing approaches to evaluating the nonmarginal tax reform
proposals, the Computable General Equilibrium modeling approach is
inappropriate for Bangladesh, both on analytical and empirical grounds. An
alternative approach, which is based on the equivalent variation measure
and focuses on the household and welfare side, is adopted to identify the
losers and gainers of a policy change in a heterogeneous population.

This approach involves estimating parameters of the Linear Expenditure
System for each of the 12 urban and rural household groups (based on their
levels of per capita monthly expenditure). The pattern of the results shows
that a single, uniform value-added tax (VAT) rate for all commodities, where
the rate is chosen such that it has a revenue-neutral effect, is very
regressive (relative to the current state) in its impact on the income of
different households. In general, richer households gain while the poorer
households in both urban and rural areas (the majority of the population)
lose.

This paper also explores an alternative package consisting of a basic
rate of VAT with exemptions for certain foodstuffs, plus additional excise
taxes on tobacco, commercial energy, and sugar. The choice of commodity
groups for exemptions and additional excises was facilitated by the
estimation of distributional characteristics of the goods discussed in the
text. This analysis permitted the identification of commodity groups for
VAT exemption and for the imposition of excises.

The welfare consequences of the alternative package is found to be much
less regressive relative to the uniform, proportional VAT case. It is
therefore likely to be more acceptable to the general public and to
policymakers.