Progressivity-Improving VAT Reforms in Italy

International institutions are recommending policies aimed at shift- ing the tax burden from labour and business incomes to less growth- detrimental forms of taxation, such as consumption taxes. However, de- spite the expected positive macroeconomic effects, a criticism about in- creasing the role of Vat arises from its alleged regressivity over income. Yet, the empirical evidence on this issue is very narrow due to the unavail- ability of joint and detailed data on income and consumption. This paper fills this gap by measuring the distributional impact of Vat in Italy using information on both households' expenditures and incomes integrated in a micro simulation model (EGaLiTe). The paper shows that the regressive profile of Vat in terms of disposable income is almost entirely driven by the very bottom and the top quantiles, which however, at least in part, can be affected by temporary unalignments of income and consumption. Fur- thermore, the current Vat structure in Italy is not optimally targeted to distributional aims, and a different allocation of goods among the existing three rates could mitigate the regressive impact of the tax. In addition, unlike the common opinion that reducing the number of Vat rates would compromise distributional outcomes, it is shown that a two-rate Vat could generate a better distributional impact compared to the current arrange- ment. Finally, the paper proposes a methodology to take into account behavioural responses to price changes in order to assess possible day- after repercussions on the aggregate demand for consumption related to alternative simulated reforms.