The temporary reduction of indirect taxes, such as VAT, with the aim of alleviating inflationary pressures on essential goods on household budgets (to absorb the loss of purchasing power), is one of the worst solutions available in economic policy, especially if it is is intended to help the most vulnerable families, defends the Technical Budget Support Unit (UTAO).
The new UTAO study (link here, opens directly in PDF) argues that it is better to provide targeted support (direct grants) to people who need it most; in the case of VAT on food, people with lower incomes who therefore spend a larger part of their monthly budget on these types of basic expenses.
Firstly, because even if companies allow the VAT reduction set by the government to be reflected in the final price, some of this “indirect subsidy” will always remain in the pockets of entrepreneurs, according to several studies cited by the unit coordinated by economist Rui Baleiras.
In addition, the VAT decision on certain foodstuffs (although the UTAO does not give the example of 0% VAT), even if temporary, is an economy-wide measure and can thus contribute to rising inflation. “Fiscal policy should not contradict the anti-inflationary orientation of monetary policy,” the economist warns.
Secondly, VAT reduction is not very effective and does not take advantage of the best practices that exist for this. This is because there are other instruments that, more than proven, are more effective in providing the support desired and conceived by the government, defends UTAO: direct subsidies and targeting families according to their income yield better results and maximize the state coffers available, for example .
This week, the government announced that it will apply a 0% VAT rate to a basket of essential food products (approximately 44 goods) and strengthen production support.
The measure lasts only six months (April to September) and costs the state budget about 600 million euros.
With this in mind, the entity that supports Parliament in budgetary and economic matters has just launched the pre-edition of a study that is a “book”, a manual on the problem of inflation and ways to combat it.
Co-ordinated by Rui Baleiras, who himself wrote the work in collaboration with António Antunes and Jorge Faria Silva, the manual titled “Inflation: A Pedagogical Study of the Dilemmas Facing Economic Policy” argues that “in general, only a portion of the government expenditure with indirect subsidy [redução do IVA ou do ISP, por exemplo] translates into a reduction in the price that families pay”
This is because “by creating a difference between the price that families have to pay and the price that firms receive, it changes the incentives of both in the market”.
“Whether they are aware of this or not, both agents will fight to get the largest possible fraction of the subsidy per unit of traded good” and therefore “the outcome will depend on the bargaining power of the parties”.
“Except in extreme situations of perfectly rigid demand and perfectly elastic demand, which are implausible in the real world, the greater the relative power of supply over price formation, the smaller the drop in price demand can accommodate,” the economists argue.
Inflation expectations may be biased
It must also be acknowledged that many consumers are insensitive to the VAT reduction, making the measure economically and politically less effective. “The fact that consumers can be so happy with different bundles with more units of one good and less of another means that a direct subsidy is never worse than an indirect subsidy”.
That is, the direct subsidy is visible and tangible, the VAT is an indirect tax and not infrequently silent. In other words, many consumers do not feel this decline and will continue to think that the goods they consume (basket) are more expensive. This raises expectations that fuel the idea that inflation will remain high. The idea of central banks is precisely to counter this idea.
Isabel Barros, the president of the Portuguese Association of Distribution Companies (APED), said yesterday: “I am sure that together we will ensure an excellent implementation of this measure [redução temporária do IVA de 44 alimentos para 0%].
The Minister of Finance has been informed. He says that with the pact signed between the government and representatives of distribution (APED) and production (CAP farmers), Fernando Medina believes that “the conditions have been created to make VAT zero, with an agreement” and that the value of the uncollected VAT “goes into the pocket” of the Portuguese.
Luís Reis Ribeiro is a journalist for Dinheiro Vivo
Source: DN
