The working paper examines the efficiency of the Value Added Tax (VAT), focusing on its role as a revenue-raising tool and its use to achieve non-revenue objectives.
The Fiscal Affairs Department of the International Monetary Fund (IMF) released a working paper titled “Efficiency Aspects of the Value Added Tax” in June 2025, focusing on its role as a revenue-raising tool and its use to achieve non-revenue objectives.
The analysis highlights the VAT’s potential ability to generate revenue with minimal distortions, emphasising its advantages over alternative taxes, such as turnover taxes and tariffs, particularly in minimising the cascading effects of input taxation.
The paper also examines VAT as a macroeconomic policy tool, particularly in counter-cyclical fiscal policy, and its potential to address environmental and health objectives. It concludes that a well-designed and implemented VAT is a highly efficient revenue-raising tool, surpassing other forms of consumption taxation, but cautions against its misuse in industrial policy and different contexts for which it is ill-suited.
To begin, one needs some clarity on what is meant by ‘efficiency,’ a term that is often used with little precision. Here, we take it to mean minimising the resources used in pursuing whatever the objective to hand may be. This is intended as a more accessible formulation of the fundamental notion of ‘Pareto efficiency’: A situation in which it is impossible to make one person better off without making someone else worse off.
In some contexts, we follow the conventional practice of supposing there to be a single representative consumer, so that efficiency boils down to maximising their well-being subject to some kind of constraint. Importantly, the pursuit of efficiency as we use the term here is not necessarily a matter of maximising output or GDP.
Reducing harmful emissions may require reducing output; efficiency, in that context, means minimising the fall in output required to achieve a given level of emissions reduction. It is not always easy to operationalise this very general idea of efficiency, but it provides a basis for some analytical rigour and, with added assumptions, in some cases enables rough quantification of the potential efficiency effects from the VAT.
In focusing on efficiency concerns, this paper sets aside, as far as possible, issues of equity and fairness around the VAT: see e.g. De la Feria and Swistak (2024). They must, however, be touched on here too, as the two sets of issues are not completely separable. Equity objectives may require compromising efficiency in the pursuit of other objectives, for example, but that compromise can be achieved in more or less efficient ways.
While they thus need to be recognised, equity aspects of the VAT are addressed in this paper only in so far as they affect what the pursuit of efficiency requires.
