Relative Contributions of Indirect Taxes and Inflation on Inequality: What Does the Turkish Data Reveal

Abstract

One way inflation affects consumption inequality is through its varying impact on the purchasing power of different households. Indirect taxes, which affect commodity price levels, are another effective factor influencing consumption inequality. Turkey is a highly unequal country with a long history of high inflation. Moreover, indirect taxes have been used frequently as a policy tool in the last decades. This study develops a novel approach to examining the relative contributions of household inflation rates and indirect tax changes to real consumption inequality and applies it to the case of Turkey. The analysis is carried out using both household-level data and artificial panel data created to apply the Shapley and Owen decomposition methods. The findings roughly can be summarized in two points. First, while nominal consumption during the 2003-2019 period became more equal, real consumption inequality increased as a result of price changes during that time. Variations in household inflation rates are the primary source of increased inequality. Second, changes in indirect taxes account for 31% to 68% of the unequalizing effect of price changes, depending on the method used. Results imply that monetary and indirect tax policy mix have been in favor of the rich in this period.