VAT Holiday Bleg

Can a cut in value-added tax stimulate economic growth?

In the United States, when we debate whether tax cuts can stimulate a sluggish economy, we are typically thinking of income tax cuts. But such cuts tend to maximize inequality and are also slow to have an impact (not everyone has an income-generating opportunity sitting in front of them just waiting for a lower tax rate).

Many other governments around the world have an additional policy alternative available, which is to cut value added tax. VAT runs as high as 25% in some countries. Unlike an income tax cut, a VAT cut would be felt instantly and would be progressive in impact.

My bleg: Has any country tried a VAT holiday to stimulate their economy, and if so what happened? If there are no policy experiments, are there any modelling white papers at which I could take a look?

Thanks in advance.

Author: Keith Humphreys

Keith Humphreys is the Esther Ting Memorial Professor of Psychiatry at Stanford University and an Honorary Professor of Psychiatry at Kings College London. His research, teaching and writing have focused on addictive disorders, self-help organizations (e.g., breast cancer support groups, Alcoholics Anonymous), evaluation research methods, and public policy related to health care, mental illness, veterans, drugs, crime and correctional systems. Professor Humphreys' over 300 scholarly articles, monographs and books have been cited over thirteen thousand times by scientific colleagues. He is a regular contributor to Washington Post and has also written for the New York Times, Wall Street Journal, Washington Monthly, San Francisco Chronicle, The Guardian (UK), The Telegraph (UK), Times Higher Education (UK), Crossbow (UK) and other media outlets.

12 thoughts on “VAT Holiday Bleg”

    1. Reading the Guardian story, it appears that it was not the cut that caused the collapse. Rather, it was the economic collapse the cut was supposed to counter.

      1. Yes, this text from the Guardian article suggests that the taxes that were not cut also brought in sharply decreased revenue, suggesting that it was general economic downturn:

        VAT receipts in July were down by a third on the same month last year, corporation tax was down 37.9% and there was a 10% decline in income tax, capital gains tax and national insurance contributions.

        1. I didn’t want to suggest that VAT holiday was entirely responsible to the drop in revenue. But any tax holiday would result in a drop in revenue. That’s the purpose of it, isn’t it? It might be exactly what is needed, of course, if the economy is in a recession. My guess is, however, that for some taxes, particuarly for VAT (because of the way it is collected), holidays may be difficult to administer. Sales tax holiday might have an advantage in this respect. But progressive income taxes serve as an automatic stabilizer, because lower incomes put people in lower tax brackets, resulting in an automatic tax cut. Of course, I do not wish this type of a tax cut on anybody.

          1. I get you Michael. Yes, it would result in revenue loss (though not dollar for dollar because presumably people who sell things would do better business and thereby pay higher income tax) which could be traded off if there is a big surge of consumer spending that generates economic growth.

  1. Not sure how applicable it would be but TX, and probably other locales, have sales tax free weekends at times. The one in TX is in August for back to school purchases. They may not be comparable since people know they are going to happen so postpone purchases until that weekend, and they are a really short period of time.

  2. Modeling the UK holiday: Crossley, Thomas, Low, Hamish, and Wakefield, Matthew. (2009). “The economics of a temporary VAT cut.” London: Institute for Fiscal Studies.

    “2. There are two mechanisms through which the temporary VAT cut might affect spending:
    first, it will increase spending power, making households feel as if they have more income.
    This mechanism is likely to be small partly because the tax cut increases income only for one
    year, and so the increase in total lifetime resources is very small, and partly because the lost
    revenue will have to be paid back.
    “3. However, the second (often ignored) mechanism is likely to be much more important. This
    second mechanism is the effect that the tax cut will have through changing the price of goods
    bought in 2009 compared to 2010: the cost of goods bought in 2009 has fallen compared to
    goods bought in 2010 and this change in prices gives an incentive to bring forward consumer
    spending to this year, rather than waiting until next.”

  3. I may be reading too much into it, but paragraphs 1 and 2 of the original post seem to present two alternative theories of the usefulness of tax cuts in an economic slump. Paragraph 1 suggests that tax cuts are aimed at getting producers to produce more, and the likelihood of their success should be judged on that basis: “not everyone has an income-generating opportunity sitting in front of them just waiting for a lower tax rate”.

    Income-generating opportunities aren’t point of tax cuts as economic stimulus – after all, the US, UK and Germany, most prominently, are awash in cheap money right now and their economies are struggling. There’s plenty of cash around to take advantage of income-generating opportunities. The argument in favor of a tax cut is that it will stimulate spending.

    And so tax cuts (as economic stimulus) need to go to people who will spend, not save. So yeah, a VAT cut/holiday at least theoretically makes more sense than tax cuts for the wealthy.

  4. The big question is whether a government simply reduces the tax (leaving people with more to spend and thus in theory stimulating the economy) or matches the tax reduction with a reduction in spending (typically on social services, which underprin the highest-velocity segment of most economies), thereby tanking the economy.

  5. If we’re going to be intellectually honest about this, why not look at the opposite direction?

    A VAST number of countries have, on multiple occasions, raised their VAT rate. I’m unaware of any particular line of argument that this crippled, or in any way really, affected their economies. This obsession with tax rates, especially at the level of individuals, and their ability to cure or exacerbate all ills strikes me as a particularly American obsession, and one that is not especially healthy. My guess would be that the business equivalents on this sort of thing (like extending the R&D tax credit on capital expenditures through 2013 and 2014) are VASTLY more productive in terms of shifting future expenditures forward per dollar forgone, because the target for these taxes actually PLAN their expenditures carefully and over a long time horizon.

    I’m a leftist and I’m unhappy with the idea of tax breaks that are targeted at business, but I’m also based in reality. If we’re going to do this sort of monkeying around, let’s make a deal whereby the businesses get an incentive to move expenditures forward, along with a compensating increase in rates starting in 2014 (or based on when GDP growth rate hits 3% or whatever).
    Targeting sales tax/VAT strikes me as the worst sort of idea — a way to increase the deficit (with all the future posturing that gets us) for very little actual stimulus boost.

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