Study of Japanese reduced VAT on food vs welfare support
Which is most effective for social aims – reduced VAT rates on food or direct welfare support? A fascinating study by Fei Goo at Waseda University reveals governments should concentrate on more targeted support for the less-well-off.
Gao, Fei, Redistribution Through Consumption Taxes: Evaluating Japan’s Dual-Rate Reform. Available at SSRN: http://dx.doi.org/10.2139/ssrn.5240209
Japan’s case highlights that while reduced rates offer limited redistribution, a more effective policy might involve targeted fiscal instruments that directly enhance welfare without compromising fiscal balance. Differentiated VAT rates, combined with behavioral insights and robust administrative capacity, can be powerful tools for social equity and economic efficiency, particularly in aging societies with rising fiscal pressures.
Japan’s reduced 8% Consumption Tax on food
The paper explores the redistributive impact of Japan’s dual-rate consumption tax system, introduced as part of the 2019 reform.
The 2019 reform introduced a reduced consumption tax rate on essentials, such as food and beverages, with the intention of softening the burden on low-income households. The paper’s analysis finds that while this reduced rate provides some equity gains, it only partially mitigates the inherent regressivity of consumption taxes. The paper’s model suggests that a welfare-maximizing approach would go further: implementing a small net subsidy on essentials, coupled with higher taxation of non-essential goods. This strategy boosts the purchasing power of lower-income households, who spend a larger share of their income on basic necessities.
Global doubts on effectiveness of reducing rates on essentials
However, this optimism around reduced consumption tax rates warrants critical re-examination. Recent research by Blasco et al. (2023) challenges the assumption that consumption taxes enhance social equity. In their study of several European countries, they find that consumption taxes remain regressive, even when governments apply reduced rates or exemptions to essential goods. Because lower-income households allocate a higher proportion of their income to consumption, they shoulder a disproportionately large tax burden relative to their disposable income.
Notably, the regressive effect persists even in countries like Germany, where reduced VAT rates are applied to food, beverages, and newspapers—similar to Japan. These findings raise an important policy question: Do reduced rates on essentials genuinely improve equity, or could alternative approaches—such as direct subsidies or targeted transfers—deliver better outcomes for household welfare and income distribution?
In conclusion, the evidence suggests that governments seeking to reform consumption taxes should move beyond simple rate reductions. In economies like Japan, a net subsidy on essentials—even modest—can outperform reduced rates in boosting welfare, while maintaining budget neutrality through higher taxation on luxury or non-essential goods. Smart consumption tax design, grounded in realistic household behavior, remains central to reconciling equity and efficiency in modern tax systems.
