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Durable Consumption, Limited VAT Pass-Through and Stabilization Effects of Temporary VAT Changes

Author

Listed:
  • Marius Clemens
  • Werner Röger
Abstract
This paper revives the question of whether a temporary VAT change is an adequate instrument for crisis stabilization. In empirical assessments, we find that durable goods consumption fluctuates strongly over the business cycle and that VAT rate changes affect durable goods in particular. Therefore, we build a dynamic stochastic general equilibrium (DSGE) model that is capable of addressing this major channel through which temporary VAT changes affect the economy. Furthermore, we allow for an imperfect pass-through of VAT measures to consumer prices via VAT-specific price adjustment costs. We compare the general VAT policy in the crisis with alternative stabilization policies, such as interest rate cuts, spending policies and a VAT cut only for durable goods. First, we find that considering durable goods in the model generates sizeable stabilization effects of VAT changes on consumption over a broad set of parameter ranges. Second, we find that the VAT policy can mimic monetary policy with minor exceptions. Third, the VAT rate cut has the highest short-term multiplier compared with government spending policies, but not in the medium-term. Fourth, a VAT rate reduction only on durable goods will generate strong GDP effects and even be self-financing in the first year. In contrast, a VAT reduction only on non-durables has small effects on GDP and is not self-financing. In view of our results, we conclude that a temporary VAT cut, when applied to durable goods, is an effective stabilization instrument.

Suggested Citation

  • Marius Clemens & Werner Röger, 2022. "Durable Consumption, Limited VAT Pass-Through and Stabilization Effects of Temporary VAT Changes," Discussion Papers of DIW Berlin 2004, DIW Berlin, German Institute for Economic Research.
    • Handle: RePEc:diw:diwwpp:dp2004
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    References listed on IDEAS

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    Cited by:

    1. Victoria Baudisch & Matthias Neuenkirch, 2023. "Costly, but (Relatively) Ineffective? An Assessment of Germany’s Temporary VAT Rate Reduction During the Covid-19 Pandemic," Research Papers in Economics 2023-04, University of Trier, Department of Economics.
    2. Winfried Koeniger & Peter Kress, 2024. "The Effect of Unconventional Fiscal Policy on Consumption -New Evidence based on Transactional Data," Swiss Finance Institute Research Paper Series 24-58, Swiss Finance Institute.

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    More about this item

    Keywords

    Value added tax; durable consumption; multiplier; business cycle; zero lower bound;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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