In this paper we analyze the incidence of the VAT and its effects on the income distribution. To
identify these effects, we rely on two tax reforms undertaken in Mexico that increased the VAT rate
for a group of cities and left the rest unaffected. We compare the inflation rate of the affected cities
with the exempted cities before and after the law changed. We find that the effect on prices is limited
and conclude that the burden of the tax is indeed shared between producers and consumers.
Regarding welfare, we find that the VAT is progressive in both absolute and relative terms to the
overall expenditure. Finally, we show that an identical change in the VAT rate when inflation is
high and persistent doubles its pass-through to inflation and its welfare loss for the average
household.
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