OECD Taxation Working Papers N. 47 – What drives consumption tax revenues? Disentangling policy and macroeconomic drivers
OECD Taxation Working Papers N. 47 – What drives consumption tax revenues? Disentangling policy and macroeconomic drivers. This paper decomposes consumption tax revenues in OECD countries into the implicit tax rate (ITR) and consumption relative to GDP, to identify how economic downturns affect consumption tax revenues. It further considers the impact of changes in VAT efficiency and VAT rates on ITRs. The analysis finds that the observed stability in consumption tax revenues results from offsetting changes in the ITRs and in consumption as a share of GDP, arising from both macroeconomic changes and intentional policy changes. During the economic crisis in 2007-2009, lasting changes in consumption patterns, notably increases in government spending and in private consumption of necessity goods, adversely affected the efficiency of VAT systems. These changes have not since been reversed, suggesting that consumption tax revenues are now less robust to economic shocks. Broadening the VAT base and narrowing the scope of reduced rates can help to stabilise consumption tax revenues during economic downturns. 1. During the economic crisis from 2007 to 2009, tax revenues from all sources fell considerably, with most countries experiencing the lowest point in their tax revenues as a share of GDP for several decades. Among these taxes, revenues from taxes on consumption were typically less affected than revenues from other bases such as corporate income. Over time, taxes on consumption have been seen to be less volatile and more stable than most other forms of taxation (OECD, 2018). This paper examines the reasons for this, disentangling consumption tax revenues to understand the impact of changes in the consumption tax base and the tax system applied to that base. 2. In addition, taxes on consumption represent a large share of both total tax revenues and GDP in OECD countries. Over the last 40 years, revenues from taxes on consumption have been relatively stable, on average, around 11% of GDP and around one-third (32.7%) of total tax revenues. However, during the same period, the mix of consumption taxes has changed markedly due to the growing share of value-added taxes (VAT), which have displaced other forms of consumption taxes in most OECD countries (OECD, 2018). 3. With all OECD countries strongly relying on consumption tax revenues, understanding what drives changes in revenues from consumption taxes is crucial for both policy makers and researchers. The aim of this paper is twofold: first, to identify through which channels consumption tax revenues are affected during an economic downturn, using the most recent economic crisis (2007-2009) as a case study; and second, to understand what drives fluctuations in the overall tax burden on consumption, using the implicit tax rate on consumption as the starting point. 4. The structure of this paper is as follows. Section 2 describes developments in consumption tax revenues across OECD countries. Section 3 reviews the existing literature on analysing changes in consumption tax revenues, before section 4 sets out the methodology used to address the two questions outlined above. In section 5, the presented decomposition is used to analyse the drivers of changes in consumption tax revenues in OECD countries, before Section 6 discusses the results of this analysis as well as avenues for future work.