Conference Agenda
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Daily Overview |
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Climate Policy 3 Location: B127 Session Chair: Deekirikewage Dona Thamali Lushanya Dayathilake, Technical University Berlin | |
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When carbon taxes beat VAT in fiscal policy: the role of informality 1: Technical University Berlin, Germany; 2: Potsdam Institute for Climate Impact Research (PIK); 3: Indian Statistical Institute, Delhi, India Emerging economies with large informal sectors have increasingly met additional revenue needs through greater reliance on the value-added tax (VAT), yet further VAT increases can be self-limiting when higher consumer prices divert activity into untaxed production. We compare two marginal revenue instruments: an invoice–credit VAT rate and an upstream carbon tax. In a two-sector model in which informal firms evade VAT on sales but bear embedded VAT via purchases of formal intermediates, we derive an implementable welfare ranking. A VAT increase raises the formal break-even price more than it raises informal marginal cost, contracting demand and formal output while expanding informality. An upstream energy tax, by contrast, does not mechanically widen the formal–informal wedge and, under empirically plausible cost-share conditions, raises a given marginal revenue target at lower welfare cost and with smaller consumer-price pass-through than an equivalent VAT increase, even before valuing emissions reductions. Carbon taxation should therefore be treated as a core fiscal tool in high-informality economies. | |