Tax Policy Transmission and Household Expenditures

Abstract Using a novel scanner data and difference-in-differences strategy, we assess how consumers respond to a large-scale tax reform in India that introduces exogenous variations in tax rate changes at the product level. We show evidence of a strong and persistent spending response to tax rate changes. The response is highly asymmetrical, with consumers responding significantly more strongly to tax rate increases than to decreases. We find empirical support for both intertemporal and cross-product substitution effects: Households (1) shift consumption forward preceding a tax increase and (2) substitute one good for another and alter their relative weight in the consumption basket to avoid paying higher tax. Heterogeneity analysis indicates that consumers with more personal shopping experience exhibit stronger consumption responses. Our findings have empirical implications for the efficacy of tax policy initiatives.