Tax Policy Transmission and Household Expenditures

Using a novel scanner data and difference-in-difference strategy, we assess how consumers respond to a large-scale tax reform in India that introduces exogenous variations in tax rate changes at the product level. We show evidence of a strong and persistent spending response to tax rate changes. The response is highly asymmetrical, and consumers respond significantly more strongly to tax rate increases than to decreases. We find empirical support for both intertemporal and cross-product substitution effects: Households (1) move consumption forward preceding a tax increase and (2) substitute one good for another and alter their relative weight in the consumption basket to avoid paying higher tax. Heterogeneity analysis indicates that consumers with more personal shopping exposure experience stronger consumption responses. Our findings offer empirical implications for the efficacy of tax policy initiatives