Equity vs Efficiency of Indirect Taxation in India

Abstract: Should countries with constrained income taxation use differentiated commodity taxes
for redistribution? In this paper, we quantify the equity-efficiency trade-off of indirect
taxation in India. We estimate how prices, quantities and sales adjust to a sudden rate
cut of the VAT from 28% to 18% for many non-essential products, using granular
administrative data in a difference-in-differences in design. We show that around half of
the tax reduction was passed-through to consumers via lower prices, that quantities
purchased of treated goods only modestly rose, and that reported sales increased by 5
percentage points, despite a context with opportunities to mislabel goods. These results
challenge the received wisdom on differentiated commodity taxes: taxing goods
consumed mainly by wealthy households might