The heterogeneous impact of indirect taxation

Abstract

This thesis investigates the heterogeneous effects of indirect taxation, focusing on India’s Goods and Services Tax (GST), through a macroeconomic model with heterogeneous agents, income taxation, and consumption taxes. The analysis spans both a static one-period frame work and a dynamic two-period extension to examine how tax instruments affect welfare across income groups. It studies the incidence of consumption taxation in a closed economy where the government must raise revenue to balance its budget. In the static setting, consistent with Atkinson and Stiglitz [1], linear income taxation alone is sufficient for revenue generation. A uniform consumption tax is redundant and has no effect on allocations. However, in the dynamic setting, the present-value budget constraint reveals that consumption in different periods is treated as distinct goods. Hence, an effective consumption tax becomes necessary. As a result, the government uses both income and consumption taxes to raise revenue in the dynamic setting. Our results show that GST is regressive: higher consumption taxes reduce the welfare of low-income households more than that of high-income households. The model shows that the government uses both income and consumption taxes to raise revenue in the dynamic setting. Since income taxes apply primarily to high-income house holds, while consumption taxes affect both types, an increase in consumption tax allows the government to reduce the income tax. This shift lowers the tax burden on high-income households and increases it on low-income households, who do not benefit from the reduction in income tax. This reveals that consumption tax used as a source of revenue generation is regressive in nature.