A Personalized VAT with Capital Transfers : A Reform to Protect Low-Income Households in Mexico

The VAT is the most widespread consumption tax in the world, but it is often considered highly regressive. To solve this, we propose a Personalized VAT (PVAT) jointly designed with a distributional policy. We seek for three goals: collect more, attain progressivity, and break the inter-generational dependency of low-income households. We use Mexico as case study: eliminating all VAT special regimes and generalizing the rate to 16% would add over 2.2% of GDP to fiscal revenues. However, such reform comes with high welfare negative effects on the poor. To deal with this conundrum, we present several PVAT scenarios. Our findings suggest that a PVAT could be fiscally neutral or even raise additional revenues up to 0.83% of GDP while benefiting the lowest income households. Finally, we study general equilibrium effects for a PVAT and some distributional policies including lump-sum and capital transfers. To do so we use an overlapping generations model calibrated for Mexico. Our simulations show welfare improving results via a PVAT policy that includes capital transfers, becoming a real possibility for breaking inter-generational dependency