How VAT reductions reach consumers' pockets: IME GSEVE analysis

A new informational note from the Institute of Economic and Industrial Research (IME GSEVE) analyzes the extent to which changes in Value Added Tax (VAT) rates affect final consumer prices and household incomes. The study draws on empirical data from temporary VAT reductions implemented across the European Union between 2022 and 2023, aimed at mitigating the energy crisis and inflationary pressures.

By critically reviewing 32 empirical studies covering 69 instances of VAT rate changes, the research reveals a notable difference between older and more recent periods. Until 2020, VAT reductions were typically passed on to prices at an average rate of about 50%. However, more recent studies focusing on the 2022-2023 period indicate that these reductions were almost fully reflected in consumer prices, with pass-through rates ranging from 90% to 100%.

Conversely, the report notes that the pass-through rate for VAT increases remains incomplete, averaging 74%. This suggests that businesses often absorb a portion of the increased costs to maintain their market position. The analysis places particular emphasis on small and sole proprietorships, which are dominant in the Greek economy. In these businesses, the company's profit is directly tied to the household's income. Consequently, any benefit from a VAT reduction that isn't immediately passed on through prices indirectly returns to households via self-employment and the labor market.

IME GSEVE argues that in economies with a strong presence of very small businesses, like Greece's, the ultimate benefit to households from VAT reductions is consistently greater than what is immediately apparent in price changes alone. The report also underscores the role of market structure, finding that more competitive markets exhibit higher pass-through rates compared to oligopolistic ones. Increased public awareness of VAT reduction policies and coordinated action between social partners and the government also positively influence the process. The study concludes that the redistributive effect of VAT rate changes is generally positive, although its horizontal nature limits its effectiveness compared to more targeted income support measures.