A Bad New Tax Idea Is Doing the Rounds
European governments have started cutting VAT, but this won't foster a consumer-led recovery.
Who picks up the bill?
Photographer: MARTIN BUREAU/AFPThere’s a new bad idea doing the rounds in Europe. Many governments are convinced that a reduction in value-added tax will help relaunch their economies. Some, including Germany, have already wielded the ax. Others, such as Italy and the U.K., are taking this option seriously. But the benefits of cutting VAT are limited, and the costs are large.
As with any other tax cut, the key question is who gains from it. The answer for VAT depends on a concept economists call “incidence,” which refers to how the tax burden or benefit is shared between companies and consumers. In the case of VAT, retailers can either pass on any reduction to shoppers by lowering their prices or they can keep their prices unchanged and pocket the difference. Unfortunately, research shows they’re more likely to do the latter, which wouldn’t be much use for any policymaker looking to use such cuts as a way of fostering a consumer-led recovery.