Rethinking VAT: Can tax expenditure reforms make consumption taxes more effective and progressive?

On 16 April, the 8th meeting of the ATI Community of Practice (CoP) on Tax Expenditures brought together around 50 participants in a virtual exchange that addressed one of the most pressing challenges of tax expenditures reforms: how to assess and improve effectiveness of consumption taxes while enhancing fairness and promoting greater progressivity. The CoP provides a dedicated space for ATI members, experts, and practitioners to exchange experiences in the assessment, reporting, measurement, governance, and reform of tax expenditures. The session was opened by Tais Chartouni Rodrigues of the ATI Secretariat and featured country presentations from Fernando Peláez Longinotti, Head of the Department of Economic and Tax Studies at Uruguay’s Dirección General Impositiva (DGI), who shared Uruguay’s experience in evaluating VAT tax expenditures and designing policies to address the regressivity of the system, and Rodrigo Octávio Orair, Program Director at the Extraordinary Secretariat of Tax Reform in Brazil’s Ministry of Finance, who examined how Brazil’s sweeping tax reform is redefining the concept and measurement of tax expenditures while making the system more effective. 

Uruguay: Targeted VAT refunds as an alternative to reduced rates

Fernando Peláez Longinotti opened the discussion by examining a fundamental tension in the VAT design: VAT is the country’s primary revenue source, accounting for 46.4% of total tax revenue, yet it places a heavier relative burden on low-income households. Data from national household surveys illustrate the imbalance clearly: the lowest income quintile faces a VAT incidence of 19% of disposable income, compared to 13% for the highest quintile.

Traditionally, countries address this regressivity through what Peláez Longinotti described as objective exemptions: reduced rates or exemptions applied to specific goods and services in the consumer basket, such as basic food, health services, and medicines. In Uruguay, these measures accounted for more than 5.1% of VAT revenue in forgone receipts. While effective, this approach is blunt: it benefits all consumers, regardless of income level.

Uruguay has therefore introduced a more targeted alternative: a “subjective exemption”, through which VAT refunds are directly targeted to low-income households. Beneficiaries of the Asignaciones Familiares – Plan de Equidad (AFAM-PE), a social protection programme, receive full VAT refunds on purchases up to the amount of their allowance. Since 2022, beneficiaries may add an additional refundable amount of up to $2,000, claimed through a dedicated mobile application. 

The results are striking. This mechanism costs just 0.4% of VAT revenue — a fraction of the 5.1% cost of the objective exemptions — while achieving comparable redistributive outcomes in a more targeted manner. Peláez Longinotti argued that with the right infrastructure, expanding the coverage and amount of personalised VAT refunds could not only neutralise the regressivity of VAT but potentially make it a progressive instrument.

Brazil: Tax reform and the redefinition of tax expenditures

Rodrigo Octávio Orair offered a broader perspective on Brazil’s comprehensive tax reform, examining how it reshapes not just the design of consumption taxes, but the very concept and measurement of tax expenditures. The reform, initiated in 2023 and currently in its implementation phase, addresses a notoriously complex system characterised by fragmented taxes across federal and subnational levels and between goods and services. Six taxes (PIS, Cofins, IOF-Insurance, IPI, ICMS, and ISS) are being consolidated into a dual VAT system:  a federal Contribution on Goods and Services (CBS) and a subnational Tax on Goods and Services (IBS), alongside excise taxes on goods and services harmful to health or the environment.

While the reform significantly simplifies the system, it does not eliminate tax expenditures. Major provisions — including the Simples Nacional regime for small businesses (R$57.9 billion, 0.43% of GDP), the basic food basket (R$44.7 billion), and free trade zone provisions (R$28.5 billion) — are preserved, representing 82% of existing tax expenditures. However, they are standardised into four transparent reduced rate tiers (reductions of 30%, 40%, 60%, and 100%), replacing a fragmented patchwork of sector- and product-specific provisions.

A central message of the presentation was that the reform fundamentally changes the reference tax system against which tax expenditures are measured. Under the old system, multiple regimes with different rates, credit rules, and tax bases coexisted, making the very concept of a “deviation from the norm” ambiguous. The new system introduces conceptual convergence around a clear benchmark tax system: a broad-based VAT with a single standard rate with full non-cumulativity.  This means that pre- and post-reform tax expenditure figures cannot be directly compared and would be misleading. Orair also noted that Brazil is incorporating a VAT ”cash-back“ mechanism as well, drawing on the experiences of Uruguay and Ecuador, reinforcing the trend toward personalised VAT instruments in Latin America.

Open discussion: implementation, risks, and definitions

The discussion that followed highlighted both the promise and the complexity of these reforms. Participants explored how targeted VAT refunds are implemented in practice. In Uruguay, the system builds on existing social protection infrastructure: beneficiaries are identified through AFAM-PE registries, and refunds are automatically credited when purchases are made electronically. The integration keeps administrative costs low but relies on high levels of financial inclusion. Peláez Longinotti noted that while there has been much discussion about further personalising VAT in Uruguay, the importance of VAT for total revenue and the associated risks have made this a slow process. However, the current subjective solution could be extended to other already identified groups, paving the way toward broader personalisation.

Questions were also raised about potential risks, such as beneficiaries making purchases on behalf of others, and about the feasibility of moving toward a more graduated refund based on income, expanding the coverage to a broader group of lower-income households. Peláez Longinotti acknowledged these as genuine design challenges. He noted that the current system places a cap on refunds, limited to the value of the subsidy received, which helps contain risks, but also has limited reach. On whether any provisions exist to address the implicit VAT burden on the informal sector, he clarified that no such measures are currently in place, though it is acknowledged that goods consumed in the informal market may carry an implicit tax burden if they have passed through the formal stages of the supply chain.

A conceptually rich exchange followed on whether personalised VAT refunds should be classified as tax expenditures or considered part of the benchmark tax system. Several participants weighed in and referred to various international experiences. For example, the Canadian tax expenditure report distinguishes between tax expenditures, structural tax measures, and refundable tax credits accounted for on the expenditure side. Others noted that country practices vary: While some treat reduced rates on essential goods as part of the benchmark tax system, others classify them as tax expenditures. 

Closing reflections

In closing, Agustín Redonda of the Council on Economic Policies (CEP) and the Tax Expenditures Lab highlighted the richness of the exchange and underscored the value of the CoP as a space for practitioners to learn from each other’s experiences. The session demonstrated that reforming tax expenditures is not merely a technical exercise, but one deeply intertwined with broader questions of tax fairness, administrative capacity, and the design of social protection systems.

Participants were encouraged to follow upcoming CoP meetings and continue the exchange, with further invitations to be shared by the ATI Secretariat.

Relevant links

The Community of Practice on Tax Expenditures | ATI