House Budget Office: Small benefit to prices from VAT reduction

Any proposed reductions in the Tax are not an appropriate tool for solving the structural problem of high prices, says the House Budget Office in its quarterly report.

And in particular it cites concrete evidence to support the position. As it notes, “following a thorough analysis of a large number of products in 27 member states of the European Union regarding the impact of VAT fluctuations on final consumer prices, three interesting findings emerge. First, only a small part of VAT reductions, about 6%, is passed on to final prices and only in the short term. In contrast, VAT increases are passed through to final prices by about 34%. Moreover, the reintroduction of VAT rates leads to disproportionate price increases which is to the detriment of the consumer.

Second, after a 10-month period following the VAT reduction, consumer prices return to the levels they were at before the VAT reduction. Third, VAT reductions seem to lead to an increase in business profit margins at the expense of consumers.”

And the Bureau goes on to state that “the first findings of a study focusing on the example of Spain show the VAT reduction in the first few months subsides significantly within a quarter. Taking into account the above and the competitive conditions in the Greek market, relative to the Spanish market, the Office estimates that any impact on final consumer prices from a VAT reduction in Greece, if any, is expected to be smaller or much smaller as well as more short-lived than that in Spain.”

And in concluding on this issue, the Office states that “taking into account the fiscal costs, the Office considers that any proposed VAT reductions are not an appropriate tool for solving the structural problem of high inflation. Instead, the Office, as it pointed out in its previous quarterly report, sees as necessary measures the enhancement of competition by removing bureaucratic and other barriers for new businesses, as well as the empowerment and education of consumers with information.

Regarding the course of the economy, the Office states that “the updated estimate for the annual growth rate of the economy for 2024 is 2.5% and is consistent with other updated forecasts recently published by the European Commission, the International Monetary Fund and the Bank of Greece that place the annual growth rate of the Greek economy for 2024 between 2.0% and 2.5%.”

The Office, as in previous reports, sees investment in fixed and human capital as the key pillar for strong economic growth in the long term. Investment plays a key role as it contributes to raising productivity, enhancing competitiveness and creating new and better paying jobs. Through investment, it facilitates infrastructure development, innovation and technological progress, which are essential for the sustainable development of an economy. The Office undertook an analysis of the relationship between investment, productivity and wages for the Greek economy in order to highlight the crucial role of investment in raising living standards and the well-being of citizens. In Greece, there was a strong positive relationship between labour productivity and investment, which was largely weakened by the deep economic crisis that erupted internationally in 2008 due to the sharp drop in investment and contributed to low labour productivity. At the same time, the relationship between wages and productivity was positive and remained positive after the outbreak of the economic crisis in Greece.

Greece needs to close the large investment gap, for 2023 about 8% of GDP compared to the Eurozone average, as a result of the deep economic crisis. The turbulence of recent years, heightened uncertainty and lack of financing are delaying a systematic investment boom. “It is therefore extremely critical, as we highlighted in our last quarterly report, to accelerate the disbursement of the Recovery and Resilience Fund to fill a significant part of the country’s investment gap. At the same time, spearheaded by the new National Investment Fund, priority should be given to financing high-tech and value-added investments. With the successful completion of investments and reforms by 2026, we will be able to speak with greater certainty about the shift of the Greek economy towards a higher value-added production model that gradually moves away from private consumption and towards investment and exports.”

Finally, the Office proceeded “to an analysis of GDP inflation in its main components, to draw conclusions on the contribution of labour costs and corporate profits to its evolution, particularly since the period of the pandemic and the war in Ukraine which exacerbated inflationary pressures. The analysis shows that profits had more than double the contribution to the cumulative increase in deflationary GDP by 2024 relative to wage costs.

But the momentum of earnings has slowed significantly from Q1 2023 to Q1 2024, and during this period the share of wage costs in GDP inflation exceeds the share of earnings by about twice as much as the share of earnings. This analysis provides strong evidence that firms, either for reasons of reduced competition, or due to increased demand driven by increased household savings stock and tourism, have been able to pass on increases in imported costs to prices and significantly boost their profits, especially during the strong phase of inflationary pressures.”

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