The objective of this study is to provide a retrospective evaluation of the consequences, in economic terms, of the functioning of the most pertinent elements of the current EU VAT system. The observation that the VAT is the most prevalent type of consumption tax in the world seems to indicate that VAT has significant attractions. However, the functioning of any consumption tax system can be evaluated on the basis of three criteria: Fairness in the tax burden distribution, Economic efficiency regarding producer and consumer choices, Minimization of administration and compliance costs, error and fraud. The study is structured along the following lines: Overview of the current VAT system; VAT administration, enforcement and compliance costs; VAT and intra-community competition; VAT and external competitiveness; The effect of VAT on price-setting behaviour; Microeconomic analysis of the effects of VAT rates and structure; Macroeconomic effects of VAT rates and structure.
As part of a large consortium executing this research project, the Public Finance Department contributes to the analysis of the effect of VAT on price-setting behaviour by a study of the recent change in the VAT rate on hotels in Germany. As part of the “Growth Acceleration Law” (Gesetz zur Beschleunigung des Wirtschaftswachstums), which became effective on January 1st, 2010, the VAT rate on accommodation services was reduced from the standard rate of 19 percent to a reduced rate of 7 percent.
The study will analyze this reduction from different perspectives. First, a bird’s eye view will be given by looking at macroeconomic data on consumption expenditure on hotels. Second, deeper insights will be obtained from data on the consumer price index, disaggregated for hotel services. A thorough analysis of the monthly development of the price index over time will provide information on how much of the reduction in the VAT rate has been passed on to consumers, if at all. In order to quantify the isolated VAT effect on prices that is observable hitherto, a difference in difference approach is adopted, taking into account various other factors. Furthermore, it is planned to apply methods of intervention analysis to analyse the timing structure of price adjustments. Third, additional information on the incidence of the change in VAT can be gained from monthly data of the Ifo business survey, which reports firms’ expectations of future changes in their own prices.
The aggregate data on consumption expenditure used for the macroeconomic view can be obtained from the German Federal Statistical Office (Fachserie 18, series 1.2). The national account series contains detailed figures on aggregate private consumption expenditure in Germany, on an annual basis. Expenditure is reported for a huge variety of goods and services both at current prices and price adjusted. For the second part of the analysis, we rely on the Harmonised Index of Consumer Prices (HICP) which the Federal Statistical Office calculates for Germany since 1997 for European purposes. The HICP is used to measure inflation in the context of international, mostly inner-European comparisons. Its calculation reflects the development of prices in the individual states based on national consumption patterns. The third part makes use of monthly micro-data, which is provided by the Ifo business survey in the services. This monthly survey among the business-oriented segments of the German service sector consists of approximately 2,500 company responses, which comprise a variety of service sub-segments, such as hotel and gastronomy, transportation, telecommunication and others.
The study shows that the reduction of the VAT rate on hotels was passed on to consumers to a limited extent only. We find that pass-through did not happen instantaneously but was extended over a long period and seems to continue until the present. The total pass-through of the tax relief is estimated to be 28.4 percent after 15 months. These findings are in line with our theoretical expectations that pass-through would be rather low and that it would not happen immediately after the reform, since it was announced at very short notice.
Main report (PDF)
Executive summary (PDF)
Formal answers to evaluation questions (PDF)
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