Revisiting Personalized VAT: A Tool for Fiscal Consolidation with Equity

As the COVID-19 pandemic ends, the large fiscal imbalances will require Latin American and Caribbean (LAC) governments to pursue fiscal consolidation policies by increasing revenues and/or reducing expenditures. VAT represents 40 percent of total revenues in the region but has a regressive impact that can be mitigated through two alternatives. The first, so called the “universal” strategy, provides relief by identifying those goods and services that account for a large share of consumption among lower-income households and, exempting or taxing them at a reduced rate. Its main weakness stems from the fact that it implies forgoing revenue which could be used to finance public social spending. Additionally, untargeted tax relief confers greater benefits, in absolute terms, to those who consume the most, usually individuals in the upper deciles of the income distribution, and also, multiple rates and exemptions introduce complexity into the management of the tax. The alternative, Personalized VAT (P VAT) strategy presented in this study for four LAC countries overcomes VATs regressivity without puncturing the tax base as the “universal” solution does. P Vat consists of three elements: (i) broadening the tax base, (ii) moving towards a single VAT rate, and (iii) implementing a tax refund for intended beneficiaries, based on the incidence of VAT on consumption among the poorest deciles. Currently, five LAC countries and one Brazilian state are implementing this mechanism.