Revisiting Indirect Tax Reform in Developing Countries

M. Shahe Emran and Joseph E. Stiglitz (2005) show that a revenue-neutral indirect tax reform, in which the value added tax (VAT) is increased to compensate for the revenue loss from tariff cuts, reduces welfare due to strong substitutability in consumption between formal and informal commodities. This paper reconsiders the above influential result, showing that indirect tax reform, if designed in a consumption-neutral fashion, improves welfare even under the strong substitutability. The revenue and distributional implications of this reform are discussed