Who pays for a VAT hike at an international border?

Abstract This research studies the effects of a value added tax (VAT) reform that raised the rate from 11 to 16 per cent at localities close to international borders in Mexico. Using difference‐in‐differences, we find that the VAT hike increased prices by one‐third the size of the full‐passthrough counterfactual. Moreover, we find that workers absorbed part of the VAT hike, as the reform had a negative effect on workers’ compensation. Informality, competition across the border, worker mobility and earnings level drive the effects we find.