Poverty and Social Impact Analysis by the IMF : Review of Methodology and Selected Evidence

Robert Gillingham

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 2008
• eBook ISBN: 9781589066625

NONE

III. The Distributional Impacts of Indirect Tax and Public Pricing Reforms: A Review of Methods and Empirical Evidence¹⁶

A. Introduction

It is common for governments in developing countries to manipulate prices of goods and services using a range of policy instruments and institutional arrangements. The motivations behind these price manipulations reflect varying objectives, such as the need to raise revenue, the desire to redistribute income toward the poor or toward politically important groups, the desire to provide protection to domestic producers, or the desire to influence the levels of supply or demand in other related markets where prices cannot easily be influenced.¹⁷ For example, the major source of revenue in most developing countries is commodity taxation such as domestic sales and excise taxes and taxes on international trade (Burgess and Stern, 1993; and Keen and Simone, 2004); food prices are often kept artificially low for consumers in order to increase the real incomes of poor households (Pinstrup- Andersen, 1988; and Gupta and others, 2000); and public sector prices (e.g., of electricity, gas, petroleum, coal, other fuels, fertilizers) are also often controlled by governments, reflecting either the perceived strategic importance of these inputs for development or the need to provide these sectors with an independent source of revenue and thus greater financial autonomy (Julius and Alicbusan, 1986).

Reform of these indirect tax systems and publicly controlled prices is often an important component of many structural adjustment programs. Reform of indirect tax systems can take various forms, such as reducing high trade taxes and replacing lost revenue through other indirect taxes, replacing trade and sales taxes with a value-added tax, broadening the value-added tax base to include previously exempt goods and services, or simply raising existing tax rates (Abed and others, 1998; and Barbone and others, 1999). Reform of publicly controlled prices typically involves raising subsidized prices closer to world or cost-recovery prices or possibly replacing government price controls with market-determined prices (Gupta and others, 2000).

Governments and other stakeholders commonly express concerns regarding the potential adverse impact of these reforms on poverty. The desirability of these reforms is usually motivated primarily by efficiency and fiscal considerations, that is, the desire to raise revenue with the least distortion of economic activity. However, the associated price changes can potentially decrease the real incomes of households and thus possibly increase poverty. This potential for adverse effects on poverty may underlie the reluctance on the part of governments and other stakeholders to support such reforms. A credible reform strategy therefore requires an analysis of the likely impacts of proposed reforms on household real incomes and the distribution of these across households, with a particular emphasis on the impact on the poorest households. The insights from these analyses should influence program design (i.e., the structure of tax reforms as well as the speed and sequencing of their introduction), as well as inform the choice of alternative approaches to mitigating these adverse effects.

The objective in this chapter is to set out the various methodological approaches that can be used to analyze the impact of tax and price reforms on household real incomes, to explain how these are related and compare their resource requirements, and to identify general policy lessons from existing empirical studies. Section B describes the various methodological approaches used in the literature and identifies their time, data, and skill resource requirements. It supplements the more general discussion of alternative methodologies in Chapter II by providing a more detailed discussion of methodologies in the context of tax and price reforms. As in Chapter II, the alternative approaches are separated into three categories: partial equilibrium, limited general equilibrium, and general equilibrium approaches. This classification is motivated as follows. The total impact on household welfare can be separated into the direct effect on households arising from the price effects of the reforms and the indirect effect that results once households and firms respond by changing their demand for and supply of goods and services and factors of production (which result in efficiency and revenue impacts). The net distributional effect will depend on the magnitude of these indirect effects and how these indirect effects are distributed across households, such as how the extra revenue is spent. General equilibrium approaches allow for all commodity demand and factor supply responses and thus incorporate both the direct and indirect welfare effects of the reforms. Limited general equilibrium approaches typically focus on a subset of price reforms (e.g., agricultural price reforms) and/or allow for only a subset of household responses (e.g., responses in closely related markets or demand responses alone), thus incorporating only a subset of the indirect effects. Partial equilibrium approaches focus only on the direct effect of reforms on prices and household real incomes.

Section C reviews the findings of the empirical literature using these various approaches and identifies general lessons for policy reform. Reforms that replace trade and sales taxes with a value-added tax typically increase the progressivity of the tax system only if food is exempt or zero-rated. Relatively higher taxes on commodities consumed mostly by higher-income groups (e.g., through additional excise taxes on some energy products) can further increase tax progressivity. It is also important to allow for home consumption of unprocessed food by farm households when evaluating the distributional implications of agricultural pricing reforms because the pattern of market trades, not the distribution of total consumption, determines distributional implications. Incorporating the efficiency consequences of tax reforms through the use of more general equilibrium methodologies is especially important in the context of the reform of trade taxes owing to the narrower tax base (i.e., imports and exports as opposed to total consumption). In general, although narrower tax bases (e.g., in the case of trade taxes or agricultural taxes) may introduce greater potential for improving the progressivity of taxes through tax differentiation, a more inefficient tax structure usually results.

Section D concludes with a summary of the methodological and policy lessons suggested by the review. The argument is made that partial equilibrium analyses can provide very useful insights into the distributional implications of tax and price reforms but should be combined with at least a qualitative discussion of efficiency issues when policy advice is given. General equilibrium analyses are required to quantify the likely magnitude of the efficiency implications of such reforms and are likely to be especially important in the context of trade tax and agricultural pricing reforms.

A more comprehensive analysis of tax and price reforms would need to address other important determinants of successful reform strategies, particularly the administrative and political constraints on reforms. The fact that such issues are not addressed in this chapter should be interpreted not as an implicit assessment of their relative importance for policy advice but rather as a desire to keep the review manageable and focused. Such issues are addressed only indirectly insofar as they influence the set of tax and price reforms under consideration. Note also that the equity and efficiency implications of reforms can be expected to influence both the need for administrative reforms and the likely political economy of reforms.

B. Alternative Methodological Approaches

One can distinguish among three methodological approaches to the analysis of tax and price reforms: general equilibrium, limited general equilibrium, and partial equilibrium approaches. The total impact of a reform can be separated into its direct effect and indirect effect on household welfare.¹⁸ The direct effect captures the impact arising from the change in consumer prices owing to the reform, which affects household real incomes. The indirect effect captures the welfare impacts that result from demand- and supply-side responses to the reforms, which have implications for efficiency and revenue. The net distributional effect of a reform will therefore depend on the magnitude of these indirect effects and how they are distributed across households, such as how the extra revenue is spent. The three methodological alternatives differ according to the extent to which the indirect welfare effects are incorporated into the analysis. In addition, the data, time, and modeling resource requirements differ substantially across these methodological alternatives (see Appendix Table A3.1).¹⁹

Partial Equilibrium Approach

Partial equilibrium approaches focus solely on the direct effect of reforms on consumer prices and household real incomes. These studies therefore ignore all household and producer responses and focus on the first-order effect on the real incomes of households (or, equivalently, the effect on their cost of living). It is common to interpret these effects as the short-run impact of reforms, prior to household and producer responses. Household responses, such as switching consumption away from taxed goods or toward subsidized goods, tend to decrease adverse welfare impacts and increase beneficial welfare impacts. First-order effects are thus often interpreted as an upper bound on longer-term adverse impacts and a lower bound on beneficial impacts. Producer responses can affect the degree to which the incidence of taxes is pushed onto final goods prices or factor prices and thus also the overall distribution of the welfare i...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• I. Introduction
• II. A Review of Macro-Micro Approaches for Evaluating the Distributional Impacts of Macroeconomic Reforms
• III. The Distributional Impacts of Indirect Tax and Public Pricing Reforms: A Review of Methods and Empirical Evidence
• IV. Analyzing the Impact of Trade Liberalization and Devaluation on Poverty
• V. The Distributional Impact of Agricultural Sector Reforms in Africa: A Review of Past Experience
• Bibliography
• Tables
• Footnotes