Can differentiated value-added tax rates promote healthier diets? The case of Costa Rica

Abstract

In February 2023, Costa Rica reformed its basic value-added tax basket on which a reduced rate applies to “guarantee a balanced diet”. This paper assesses ex-ante the impact of the reform on nutrient availability and household spending across income groups. Price elasticities are estimated using pooled National Household Income and Expenditure Survey data and a two-step censored quadratic almost ideal demand system model accounting for price and total expenditure endogeneity. Nutritional information is derived from food composition tables. Food items are grouped by processing level as a proxy to explore differences in own- and cross-price effects between ‘healthier’ and ‘less healthy’ items. The demand for ultra-processed sweet and savoury foods is price-inelastic (−0.74 and −0.81, respectively). Lower-income households’ demand is more price-sensitive. The reform applies a reduced rate to a significant number of ultra-processed savoury food items and is associated with an increase in household purchases of calories (0.7%), sugar (0.4%), and saturated fat (1.2%). A counterfactual scenario with a basic tax basket defined based on the Pan American Health Organization nutrient profile model criteria is associated with the largest reductions in calories (−0.2%), sodium (−1.0%), and saturated fat (−0.6%), with higher benefits for lower-income households. It results in minor decreases in household spending (−0.2%). While an increasing number of countries contemplate the taxation of foods high in fat, salt, or sugar, Costa Rica is unique in mandating the consideration of nutritional aspects in determining value-added tax rates. However, the recently adopted basic tax basket may not fulfil this potential.