This article has been reviewed according to Science X's editorial process and policies. Editors have highlighted the following attributes while ensuring the content's credibility: In summer 2020, the German federal government lowered value-added tax from 19% to 16% for half a year as part of its COVID economic stimulus package. A new study, recently published in the journal Review of Economic Studies, uses survey data, data on retail purchases and an economic model to show the extent to which this measure influenced private consumption.
The study found that lower-wealth households, as well as younger and middle-aged households, particularly benefited, regardless of their level of financial literacy. The study "A Temporary VAT Cut as Unconventional Fiscal Policy" was authored by Rüdiger Bachmann (University of Michigan), Benjamin Born (University of Bonn), Olga Goldfayn-Frank (Deutsche Bundesbank), Georgi Kocharkov (Deutsche Bundesbank, European Central Bank), Ralph Luetticke (University of Tübingen) and Michael Weber (ESMT Berlin, Purdue University). The findings are based on household surveys and data on actual retail purchases during the six-month period in 2020 when the value-added tax was temporarily reduced from 19% to 16%.
In addition, the researchers simulated the reaction of different household types in a macroeconomic model. The basic idea: If VAT (value-added tax) falls today and is set to rise again in the foreseeable future, consumption becomes relatively cheaper now than it will be later. This creates an incentive similar to a cut in the key interest rate: People buy sooner rather than later.
Unlike interest-rate policy, though, a VAT change is easy for consumers to understand and has an immediate, noticeable effect. The study shows that households that perceived a strong pass-through of the tax cut to consumer prices spent around 37% more on durable goods, such as cars, in the second half of 2020 than households that perceived little or no effect on prices. For medium-durability goods, such as books, the effect was around 10%; for short-lived everyday goods, such as food, no significant effect was found.
Shortly after the measure took effect, a survey conducted in July 2020 found that households that knew the tax cut was only temporary were considerably more likely to plan major purchases than households that did not. The difference was about 10 percentage points. In the researchers' model, the measure drove up total consumption spending by 4.4% immediately after its introduction.
This is a significantly greater effect than a temporary interest rate cut of the same magnitude would have had. The reason: A tax cut directly increases households' disposable income, whereas an interest rate cut does not to the same degree. The strongest response came from younger and middle-aged households with lower net wealth, as well as particularly price-conscious "bargain hunters." Financial literacy or a long planning horizon, by contrast, played hardly any role.
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