the reduction in VAT, a gain in purchasing power in a trompe l’oeil

2023-06-01 15:04:00

Inflation continues to undermine the purchasing power of the French. More than a year following the outbreak of war in Ukraine, the price index admittedly stalled in May at 5.1% year-on-year compared to 5.9% in April, but it remains at a good level. higher than before the pandemic. On the food side, prices have also slowed, but remain very high (14%) according to the latest figures from INSEE. As a result, consumption has plummeted and purchasing power is declining. In Europe, inflation, calculated by the harmonized index of consumer prices (HICP), also slowed down from 7% in April to 6.1% according to Eurostat’s flash estimate released today.

These pressures on prices have disastrous consequences on the daily lives of many French people. In this burning context, economists and political parties are therefore seeking to find the best remedy to fight once morest soaring prices. During the morning of the economy organized at the National Assembly this Thursday, June 1, several economists returned to the various tools made available to the government to curb the overheating of prices. Among the levers mentioned is the reduction in value added tax (VAT). This proposal is a sea serpent in discussions among economists. On the political level, the entire spectrum of parties regularly advances this tool to respond to the emergency. During the 2022 presidential campaign, Marine Le Pen had widely promoted this idea in her program. But its effectiveness in restoring purchasing power to the consumer is far from proven.

Margin or true price reduction?

The reduction in VAT can be perceived as an effective and rapid tool to limit the rise in prices. By lowering the rate on a selection of food items, consumers at the bottom of the distribution might benefit given the weight of these items in their total budget. In the end, reducing VAT might appear as a measure of social justice. Indeed, indirect taxation is particularly unfair and regressive because it affects households indiscriminately regardless of their income.

But the effectiveness of this measure is controversial. “If we lower the VAT, will that benefit the consumer? Will this drop go to the margin or to a price drop? », asked the economist Thomas Gjerbine, economist at the Center for Prospective Studies and International Information (CEPII) in Paris. Indeed, there is no guarantee that a reduction in VAT would benefit consumers. In a report unveiled last February, the Council of Compulsory Levies (CPO) attached to the Court of Auditors pointed out the limits of this proposal. “A reduction in VAT, particularly on food products, is a less effective measure to support the purchasing power of low-income households than monetary transfers, due to the uncertainty regarding the rate of pass-through on prices and the impossibility of targeting certain categories of households through a reduction in VAT”.

Purchasing power: lowering VAT is “always a relatively ineffective easy solution”, recalls Pierre Moscovici

The failure of the VAT reduction in catering

In 2009, under the mandate of Nicolas Sarkozy, catering professionals demanded a reduction in VAT from 19.6% to 5.5%. At the time, restaurateurs had undertaken, by signing a contract, to share the fruits of this decline between their establishment, employees and customers. But several parliamentary reports and studies by economists have pointed to the failure of this experience in terms of redistribution.

Economists from the Institute for Public Policy (IPP), in a very documented note had shown that two and a half years following the reduction in VAT, “prices had only decreased by 1.9%, while the cost of wages and supplies had only increased by 4.1 and 5%, respectively, and owners’ profits had increased by regarding 24%”. After the 2008 crisis, inflation was relatively low. But in the current context, companies might be tempted to recover an even greater part of this reduction in VAT to cushion the rise in production costs.

A significant cost for public finances

In addition to the uncertain effectiveness noted by economists, the reduction in VAT can have major repercussions on public finances. As a reminder, this taxation on consumption is the primary source of tax revenue. In France, the reduced VAT rates represent a colossal shortfall of 47 billion euros per year, according to the council of compulsory levies. These derogatory rates relate to water, food, but also commercial passenger transport or the press. In times of inflation, a drop in the VAT rate can also represent less tax revenue given the indexation mechanisms. Far from being a miracle solution, the reduction in VAT might therefore be counterproductive.