A personalized VAT with capital transfers: a reform to protect low-income households in Mexico

The value-added tax (VAT) stands as the prevailing global consumption tax; however, its reputation often leans towards regressive. In response, we introduce the concept of a personalized VAT (PVAT) harmonized with a distributional strategy, which we term PVAT with capital transfers. Our objectives are threefold: bolster revenue collection, institute progressivity, and dismantle the cycle of intergenerational reliance among low-income households. Using Mexico as our case study, a nation characterized by pro-poor special VAT regimes amounting to approximately 2.2% of GDP, we unveil findings suggesting that the PVAT alone can maintain fiscal neutrality or even elevate revenues by up to 0.83% of GDP, concurrently benefiting the most economically disadvantaged households. Furthermore, we conduct a comprehensive analysis of the broader equilibrium effects stemming from a PVAT and an array of distributional policies, including lump-sum and capital transfers, employing a tailored overlapping generations model calibrated specifically for Mexico. Our simulations reveal welfare enhancing and output growth results through a PVAT policy that includes capital transfers, thereby presenting a viable strategy for breaking intergenerational dependency.